The Valuation of American Barrier Options Using The Decomposition Technique

Posted: 8 Feb 2001

See all articles by Bin Gao

Bin Gao

University of North Carolina (UNC) at Chapel Hill - Finance Area

Jing-Zhi Huang

Pennsylvania State University - University Park - Department of Finance

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business

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Abstract

In this paper, we propose an alternative approach for pricing and hedging American barrier options. Specifically, we obtain an analytic representation for the value and hedge parameters of barrier options, using the decomposition technique of separating the European option value from the early exercise premium. This allows us to identify some new put-call "symmetry" relations and the homogeneity in price parameters of the optimal exercise boundary. These properties can be utilized to increase the computational efficiency of our method in pricing and hedging American options.

Our implementation of the obtained solution indicates that the proposed approach is both efficient and accurate in computing option values and option hedge parameters. Our numerical results also demonstrate that the approach dominates the existing lattice methods in both accuracy and efficiency. In particular, the method is free of the difficulty that existing numerical methods have in dealing with spot prices in the proximity of the barrier, the case where the barrier options are most problematic.

Suggested Citation

Gao, Bin and Huang, Jing-Zhi Jay and Subrahmanyam, Marti G., The Valuation of American Barrier Options Using The Decomposition Technique. Available at SSRN: https://ssrn.com/abstract=254701

Bin Gao

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-0054 (Fax)

Jing-Zhi Jay Huang (Contact Author)

Pennsylvania State University - University Park - Department of Finance ( email )

University Park, PA 16802
United States

HOME PAGE: http://www.personal.psu.edu/jxh56

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

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