Analytical Approximations to the Valuation of American Options: A Boundary-Optimality Approach

Thessaloniki 2006 HFAA Conference Paper

17 Pages Posted: 9 Oct 2006

See all articles by Andreas Andrikopoulos

Andreas Andrikopoulos

University of Piraeus - Department Maritime Studies

Date Written: September 26, 2006

Abstract

The quadratic approximation to the valuation of american options on stocks is revisited, constructing a pricing approach based on the fact that the early exercise policy should be chosen to maximize the value of the option. At the first part of the paper, we apply this approach (boundary-optimality) in the setting of the pricing model suggested in Barone-Adesi and Whaley (1987). We enrich their original valuation setting with an additional parameter, computed with the help of a boundary-optimality boundary condition. This approach enhances the accuracy performance of the Barone-Adesi and Whaley (1987) approximation. In the second part of the paper we introduce a novel approximation approach, where option value is the product of two functions, one of the being a function of time and the other one being a function of the stock price. Applying the principle that the early exercise policy should maximize option value, this alternative option pricing technique provides accurate results for american call and put options.

Keywords: American options, analytical approximation

JEL Classification: G13

Suggested Citation

Andrikopoulos, Andreas, Analytical Approximations to the Valuation of American Options: A Boundary-Optimality Approach (September 26, 2006). Thessaloniki 2006 HFAA Conference Paper, Available at SSRN: https://ssrn.com/abstract=935867 or http://dx.doi.org/10.2139/ssrn.935867

Andreas Andrikopoulos (Contact Author)

University of Piraeus - Department Maritime Studies ( email )

Grigoriou Lampraki 21 & Distomou
Piraeus, GR 18533
Greece

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