On Improving the Least Squares Monte Carlo Option Valuation Method

36 Pages Posted: 5 Feb 2008 Last revised: 10 May 2018

See all articles by Nelson Areal

Nelson Areal

University of Minho - School of Economics and Management

Artur Rodrigues

University of Minho - NIPE and School of Economics and Management

Manuel J. Rocha Armada

University of Minho

Date Written: January 1, 2008

Abstract

This paper studies various possible approaches to improving the least squares Monte Carlo option valuation method. We test different regression algorithms and suggest a variation to estimating the option continuation value, which can reduce the execution time of the algorithm by one third. We test the choice of varying polynomial families with different number of basis functions. We compare several variance reduction techniques, and find that using low discrepancy sequences can improve the accuracy up to four times. We also extend our analysis to compound and mutually exclusive options. For the latter, we propose an improved algorithm which is faster and more accurate.

Keywords: American options, real options, simulation, quasi Monte-Carlo methods

JEL Classification: D81, G13, G31

Suggested Citation

Brandão da Costa Areal, Nelson Manuel de Pinho and Rodrigues, Artur and Rocha Armada, Manuel José, On Improving the Least Squares Monte Carlo Option Valuation Method (January 1, 2008). This is a pre-print of an article published in Review of Derivatives Research, 11(1-2), 119-151 (2008), Available at SSRN: https://ssrn.com/abstract=1089490 or http://dx.doi.org/10.2139/ssrn.1089490

Nelson Manuel de Pinho Brandão da Costa Areal (Contact Author)

University of Minho - School of Economics and Management ( email )

University of Minho
School of Economics and Management
Braga, 4710-057
Portugal
+351 253 601 380 (Fax)

HOME PAGE: http://nelsonareal.net

Artur Rodrigues

University of Minho - NIPE and School of Economics and Management ( email )

School of Economics and Management
Braga, 4710-057
Portugal

Manuel José Rocha Armada

University of Minho ( email )

Sch. Economics & Bus Administration
Gualtar
Braga, MINHO 4710-057
Portugal
+351 253 60 44 55 (Phone)

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