Comparison of numerical and analytical approximations of the early exercise boundary of American put options

Daniel Sevcovic, M. Lauko

Abstract


We present qualitative and quantitative comparisons of various analytical and numerical approximation methods for calculating a position of the early exercise boundary of American put options paying zero dividends. We analyse the asymptotic behaviour of these methods close to expiration, and introduce a new numerical scheme for computing the early exercise boundary. Our local iterative numerical scheme is based on a solution to a nonlinear integral equation. We compare numerical results obtained by the new method to those of the projected successive over-relaxation method and the analytical approximation formula recently derived by Zhu [‘A new analytical approximation formula for the optimal exercise boundary of American put options’, Int. J. Theor. Appl. Finance 9 (2006) 1141–1177].

doi:10.1017/S1446181110000854

Keywords


option pricing; American put option; early exercise boundary; limiting behaviour close to expiry



DOI: http://dx.doi.org/10.21914/anziamj.v51i0.2923



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ANZIAM Journal, ISSN 1446-8735, copyright Australian Mathematical Society.