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Enhanced policy iteration for American options via scenario selection

[journal article]

Schoenmakers, John; Bender, Christian; Kolodko, Anastasia

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Please use the following Persistent Identifier (PID) to cite this document:http://nbn-resolving.de/urn:nbn:de:0168-ssoar-221003

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Abstract Kolodko and Schoenmakers (2006) and Bender and Schoenmakers (2006) introduced a policy iteration that allows the achievement of a tight lower approximations of the price for early exercise options via a nested Monte Carlo simulation in a Markovian setting. In this paper we enhance the algorithm by a scenario selection method. It is demonstrated by numerical examples that the scenario selection can significantly reduce the number of inner simulations actually performed, and thus can greatly speed up the method (by up to a factor of 15 in some examples). Moreover, it is shown that the modified algorithm retains the desirable properties of the original, such as the monotone improvement property, termination after a finite number of iteration steps, and numerical stability.
Classification Basic Research, General Concepts and History of Economics; Economic Statistics, Econometrics, Business Informatics
Free Keywords American-style derivative securities; Monte Carlo methods; Optimal policies; Pricing of derivatives securities
Document language English
Publication Year 2008
Page/Pages p. 135-146
Journal Quantitative Finance, 8 (2008) 2
DOI http://dx.doi.org/10.1080/14697680701253013
Status Postprint; peer reviewed
Licence PEER Licence Agreement (applicable only to documents from PEER project)