A Replicating Portfolio Approach to Valuing American Options in Closed-Form
12 Pages Posted: 9 Jan 2021 Last revised: 19 Feb 2021
Date Written: November 19, 2020
I derive closed-form expressions for the value of American call and put options (on an asset with continuous yield) using the Feynman-Kac formula, modelling the size of early exercise premium as a function of the strike, dividend yield and time to maturity. Strategies involving European options and binary options on forwards on the asset replicate an American option exactly. Violations of Put-Call parity for American options is also explored in this framework.
Keywords: Rational Pricing, American Options, Static Replicating Portfolio
JEL Classification: C32, G13
Suggested Citation: Suggested Citation