Randomization and the Equivalent European Payoff for the American Put Option
13 Pages Posted: 4 Oct 2022
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: Suggested Citation