Using Richardson extrapolation techniques to price American options with alternative stochastic processes
Journal
Review of Quantitative Finance and Accounting
Journal Volume
39
Journal Issue
3
Pages
383-406
Date Issued
2012
Author(s)
Abstract
In this paper the authors investigate the performance of the original and repeated Richardson extrapolation methods for American option pricing by implementing both the original and modified Geske-Johnson approximation formulae. A comprehensive numerical comparison includes alternative stochastic processes of the underlying asset price. The numerical results show that whether the original or modified formula is implemented, the Richardson extrapolation techniques work very well. The repeated Richardson extrapolation strongly outperforms the original, especially when the underlying asset price follows a stochastic volatility process. Moreover, this study verifies the feasibility of the estimated error bounds of the American option prices under alternative stochastic processes by applying the repeated Richardson extrapolation method and estimating the interval of true American option values, as well as determining the number of options needed for an approximation to achieve a desired accuracy level. ? 2011 Springer Science+Business Media, LLC.
Subjects
American options
Repeated Richardson extrapolation
Richardson extrapolation
Stochastic process
Type
journal article