An efficient hybrid penalty method for pricing American options

Hongjoong Kim, Taeyoung Oh, Kyoung Sook Moon

Research output: Contribution to journalArticle

Abstract

We propose a hybrid numerical method for computing the prices of American options. In order to solve efficiently and accurately the linear complementarity problem arising in the valuation of American options, the proposed method initially applies the penalty method to annihilate the nonlinear error from the free boundary, then performs the θ-method with projection to solve the rest of the problem quickly. Numerical computations show that the proposed hybrid method is more efficient than other existing methods for a given level of accuracy.

Original languageEnglish
Pages (from-to)224-233
Number of pages10
JournalIndustrial Engineering and Management Systems
Volume16
Issue number2
DOIs
Publication statusPublished - 2017 Jun 1

Keywords

  • American option pricing
  • Hybrid method
  • Linear complementarity problem
  • Penalty method

ASJC Scopus subject areas

  • Social Sciences(all)
  • Economics, Econometrics and Finance(all)

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