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An Efficient Hybrid Penalty Method for Pricing American Options

Authors
Kim, HongjoongOh, TaeyoungMoon, Kyoung-Sook
Issue Date
6월-2017
Publisher
KOREAN INST INDUSTRIAL ENGINEERS
Keywords
American Option Pricing; Penalty Method; Linear Complementarity Problem; Hybrid Method
Citation
INDUSTRIAL ENGINEERING AND MANAGEMENT SYSTEMS, v.16, no.2, pp.224 - 233
Indexed
SCOPUS
KCI
Journal Title
INDUSTRIAL ENGINEERING AND MANAGEMENT SYSTEMS
Volume
16
Number
2
Start Page
224
End Page
233
URI
https://scholar.korea.ac.kr/handle/2021.sw.korea/83223
DOI
10.7232/iems.2017.16.2.224
ISSN
1598-7248
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 theta-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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