American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods

Posted: 22 Aug 1994

See all articles by Jerome Detemple

Jerome Detemple

Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Mark Broadie

Columbia University - Columbia Business School - Decision Risk and Operations

Multiple version iconThere are 2 versions of this paper

Date Written: July 15, 1994

Abstract

In this paper we provide lower and upper bounds on the prices of American call and put options written on a dividend paying asset. Based on the bounds, we provide two option price approximations. Our second approximation, which uses both lower and upper bound information, has an average accuracy comparable to a 1000-step binomial tree with a computation speed comparable to a 50-step binomial tree. Put another way, our second approximation is 6 times more accurate than a 200-step binomial tree and is about 15 times faster than a 200-step binomial tree. Furthermore, the approximations are sufficiently simple that they can be computed in a spreadsheet. In addition, we conduct a careful large-scale evaluation of many recent methods for computing American option prices. Comparisons are made on the basis of accuracy and speed of computation and lead to some surprising results.

JEL Classification: G13

Suggested Citation

Detemple, Jerome and Broadie, Mark, American Option Valuation: New Bounds, Approximations, and a Comparison of Existing Methods (July 15, 1994 ). Available at SSRN: https://ssrn.com/abstract=5463

Jerome Detemple

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 353-4297 (Phone)
(617) 353 6667 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

Mark Broadie (Contact Author)

Columbia University - Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-4103 (Phone)

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