Pricing American Options Using a Nonparametric Entropy Approach
This paper studies the pricing problem of American options using a nonparametric entropy approach. First, we derive a general expression for recovering the risk-neutral moments of underlying asset return and then incorporate them into the maximum entropy framework as constraints. Second, by solving...
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| Main Authors: | , |
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| Format: | Article |
| Language: | English |
| Published: |
Wiley
2014-01-01
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| Series: | Discrete Dynamics in Nature and Society |
| Online Access: | http://dx.doi.org/10.1155/2014/369795 |
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| Summary: | This paper studies the pricing problem of American options using a nonparametric
entropy approach. First, we derive a general expression for recovering the risk-neutral
moments of underlying asset return and then incorporate them into the maximum entropy framework as constraints. Second, by solving this constrained entropy problem,
we obtain a discrete risk-neutral (martingale) distribution as the unique pricing measure. Third, the optimal exercise strategies are achieved via the least-squares Monte
Carlo algorithm and consequently the pricing algorithm of American options is obtained. Finally, we conduct the comparative analysis based on simulations and IBM
option contracts. The results demonstrate that this nonparametric entropy approach
yields reasonably accurate prices for American options and produces smaller pricing
errors compared to other competing methods. |
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| ISSN: | 1026-0226 1607-887X |