An efficient hybrid penalty method for pricing American options

Hongjoong Kim; Taeyoung Oh; Kyoung Sook Moon

doi:10.7232/iems.2017.16.2.224

An efficient hybrid penalty method for pricing American options

Hongjoong Kim, Taeyoung Oh, Kyoung Sook Moon

Research output: Contribution to journal › Article › peer-review

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 language	English
Pages (from-to)	224-233
Number of pages	10
Journal	Industrial Engineering and Management Systems
Volume	16
Issue number	2
DOIs	https://doi.org/10.7232/iems.2017.16.2.224
Publication status	Published - 2017 Jun

Bibliographical note

Funding Information:
This work was supported by Basic Science Research Program through the National Research Foundation of Korea (NRF) funded by Ministry of education (NRF-2014R1A1A2058271); and by the Gachon University research fund of 2016.

Publisher Copyright:
© 2017 KIIE.

Keywords

American option pricing
Hybrid method
Linear complementarity problem
Penalty method

ASJC Scopus subject areas

General Social Sciences
Economics, Econometrics and Finance(all)

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10.7232/iems.2017.16.2.224

Cite this

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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.",

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AB - 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.

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An efficient hybrid penalty method for pricing American options

Abstract

Bibliographical note

Keywords

ASJC Scopus subject areas

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