Randomization and the Equivalent European Payoff for the American Put Option

13 Pages Posted: 4 Oct 2022

See all articles by Ciprian Necula

Ciprian Necula

Bucharest University of Economic Studies, Department of Money and Banking

Date Written: September 25, 2022

Abstract

In this paper, using randomization, we obtain, in the context of the Black-Scholes-Merton model, the Laplace transform of the equivalent European payoff for the American put, i.e. a payoff whose European price is identical, in the continuation region, to that of the American put option. We also develop a numerical procedure and conduct a numerical experiment spanning a wide range of parameters and contract characteristics. Overall, the method based on inverting the Laplace transform of the equivalent European payoff generates American option prices with a relative RMSE close to 0.004% compared to a benchmark.

Keywords: American options, European options, Black-Scholes-Merton model

JEL Classification: C63, G13

Suggested Citation

Necula, Ciprian, Randomization and the Equivalent European Payoff for the American Put Option (September 25, 2022). Available at SSRN: https://ssrn.com/abstract=4235298 or http://dx.doi.org/10.2139/ssrn.4235298

Ciprian Necula (Contact Author)

Bucharest University of Economic Studies, Department of Money and Banking ( email )

6, Romana Square, District 1
Bucharest, 010374
Romania

HOME PAGE: http://www.dofin.ase.ro/cipnec

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