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Enhanced policy iteration for American options via scenario selection
[journal article]
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... view more
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.... view less
Classification
Economic Statistics, Econometrics, Business Informatics
Basic Research, General Concepts and History of Economics
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
https://doi.org/10.1080/14697680701253013
Status
Postprint; peer reviewed
Licence
PEER Licence Agreement (applicable only to documents from PEER project)