Abstract
We provide an alternative analytic approximation for the value of an American option using a confined exponential distribution with tight upper bounds. This is an extension of the Geske and Johnson compound option approach and the Ho et al. exponential extrapolation method. Use of a perpetual American put value, and then a European put with high input volatility is suggested in order to provide a tighter upper bound for an American put price than simply the exercise price. Numerical results show that the new method not only overcomes the deficiencies in existing two-point extrapolation methods for long-term options but also further improves pricing accuracy for short-term options, which may substitute adequately for numerical solutions. As an extension, an analytic approximation is presented for a two-factor American call option.
Original language | English |
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Pages (from-to) | 449-474 |
Number of pages | 25 |
Journal | European Journal of Finance |
Volume | 9 |
Issue number | 5 |
DOIs | |
Publication status | Published - Oct 2003 |
Keywords
- Analytical approximations
- Confined exponential distribution
- Tight upper bounds
- Two-factor American option