Exercisability Randomization of the American Option

Abstract

The valuation of American options is an optimal stopping time problem which typically leads to a free boundary problem. We introduce here the randomization of the exercisability of the option. This method considerably simplifies the problematic by transforming the free boundary problem into an evolution equation. This evolution equation can be transformed in a way that decomposes the value of the randomized option into a European option and the present value of continuously paid benefits. This yields a new binomial approximation for American options. We prove that the method is accurate and numerical results illustrate that it is computationally efficient.     

A variational inequality arising from American installment call options pricing

In this paper we consider a parabolic variational inequality with two free boundaries arising from American continuous-installment call options pricing. We prove the existence and uniqueness of the solution to the problem. Moreover, we obtain the monotonicity and smoothness of two free boundaries and show its numerical solution by the binomial method.     

美式利率期权的最佳实施边界的分析

在Vasicek利率模型的假设下,应用变分不等式方法分析了美式利率期权自由边界的性质．首先我们得到美式利率期权自由边界的下界, 然后把自由边界问题化为变分不等式,通过引入惩罚函数证明了该变分不等式解的存在唯一性,最后证明了自由边界的单调性、 有界性和C∞光滑性．     

A Note on the Valuation of American Option

American options give holder a right to exercise it at any time at will, the holder should to make the exercise policy in such a way that the expected payoff from the option will be maximized. In this note we prove that it is equivalent to a fact which makes the option value and option delta continuous.     

Convexity of the optimal stopping boundary for the American put option

We show that the optimal stopping boundary for the American put option is convex in the standard Black-Scholes model. The methods are adapted from ice-melting problems and rely upon studying the behavior of level curves of solutions to certain parabolic differential equations.     

An approximate moving boundary method for American option pricing

We present a method to solve the free-boundary problem that arises in the pricing of classical American options. Such free-boundary problems arise when one attempts to solve optimal-stopping problems set in continuous time. American option pricing is one of the most popular optimal-stopping problems considered in literature. The method presented in this paper primarily shows how one can leverage on a one factor approximation and the moving boundary approach to construct a solution mechanism. The result is an algorithm that has superior runtimes-accuracy balance to other computational methods that are available to solve the free-boundary problems. Exhaustive comparisons to other pricing methods are provided. We also discuss a variant of the proposed algorithm that allows for the computation of only one option price rather than the entire price function, when the requirement is such.     

A Barrier Option of American Type

We obtain closed-form expressions for the prices and optimal hedging strategies of American put-options in the presence of an ``up-and-out" barrier , both with and without constraints on the short-selling of stock. The constrained case leads to a stochastic optimization problem of mixed optimal stopping/singular control type. This is reduced to a variational inequality which is then solved explicitly in two qualitatively separate cases, according to a certain compatibility condition among the market coefficients and the constraint. Accepted 18 May 2000. Online publication 13 November 2000.     

A new predictor-corrector scheme for valuing American puts

In this paper, we present a new numerical scheme, based on the finite difference method, to solve American put option pricing problems. Upon applying a Landau transform or the so-called front-fixing technique [19] to the Black-Scholes partial differential equation, a predictor-corrector finite difference scheme is proposed to numerically solve the nonlinear differential system. Through the comparison with Zhu’s analytical solution [35], we shall demonstrate that the numerical results obtained from the new scheme converge well to the exact optimal exercise boundary and option values. The results of our numerical examples suggest that this approach can be used as an accurate and efficient method even for pricing other types of financial derivative with American-style exercise.     

Existence and Uniqueness of Viscosity Solutions for Nonlinear Variational Inequalities Associated with Mixed Control

The author investigates the nonlinear parabolic variational inequality derived from the mixed stochastic control problem on finite horizon. Supposing that some sufficiently smooth conditions hold, by the dynamic programming principle, the author builds the Hamilton-Jacobi-Bellman(HJB for short) variational inequality for the value function.The author also proves that the value function is the unique viscosity solution of the HJB variational inequality and gives an application to the quasi-variat...     

A NUMERICAL METHOD FOR DETERMINING THE OPTIMAL EXERCISE PRICE TO AMERICAN OPTIONS

American Options can be exercised prior to the date of expiration,the valuation of American options then constitutes a free boundary value problem.How to determine the free boundary,i.e. the optimal exercise price,is a key problem.In this paper,a nonlinear equation is given.The free boundary can be obtained by solving the nonlinear equation and the numerical results are better.     

Valuing finite-lived Russian options

This paper deals with the valuation of the Russian option with finite time horizon in the framework of the Black–Scholes–Merton model. On the basis of the PDE approach to a parabolic free boundary problem, we derive Laplace transforms of the option value, the early exercise boundary and some hedging parameters. Using Abelian theorems of Laplace transforms, we characterize the early exercise boundary at a time to close to expiration as well as the well-known perpetual case in a unified way. Furthermore, we obtain a symmetric relation in the perpetual early exercise boundary. Combining the Gaver–Stehfest inversion method and the Newton method, we develop a fast algorithm for computing both the option value and the early exercise boundary in the finite time horizon.     

American Options Exercise Boundary When the Volatility Changes Randomly

The American put option exercise boundary has been studied extensively as a function of time and the underlying asset price. In this paper we analyze its dependence on the volatility, since the Black and Scholes model is used in practice via the (varying) implied volatility parameter. We consider a stochastic volatility model for the underlying asset price. We provide an extension of the regularity results of the American put option price function and we prove that the optimal exercise boundary is a decreasing function of the current volatility process realization. Accepted 13 January 1998     

Optimal stopping-time problem for stochastic Navier–Stokes equations and infinite-dimensional variational inequalities

We prove the existence of a solution for the obstacle problem associated with the Kolmogorov operator corresponding to the stopping-time problem for stochastic Navier–Stokes equations in 2-D.     

An unconditional existence result for the quasi-variational elastohydrodynamic free boundary value problem

In this paper a two-dimensional quasi-variational inequality arising in elastohydrodynamic lubrication is studied for non-constant viscosity. So far, existence results for such piezo-viscous problems require an L^∞ property for an auxiliary problem. For the usual pressure-viscosity relations, this property needs small data assumptions which are not observed in experimental conditions. In the present work, such small data assumptions are proved unnecessary for existence results. Besides well-established monotonicity behavior for the viscosity-pressure relation, the only condition used here is on the asymptotic behavior for this law as the pressure tends to infinity. If the procedure used here, namely the introduction of a reduced pressure by Grubin transform followed by a regularization procedure, appears somewhat classical, the way in which an upper bound is obtained is completely new.     

Optimal Shape Problems for Eigenvalues

ABSTRACT

We consider the first Dirichlet eigenvalue for nonhomogeneous membranes. For given volume we want to find the domain which minimizes this eigenvalue. The problem is formulated as a variational free boundary problem. The optimal domain is characterized as the support of the first eigenfunction. We prove enough regularity for the eigenfunction to conclude that the optimal domain has finite parameter. Finally an overdetermined boundary value problem on the regular part of the free boundary is given.     

A variational inequality formulation for unconfined seepage problems in porous media

In the existing variational inequality formulations for the unconfined seepage problem in porous media, the seepage point, namely the exit point of the free surface, is a singular point and how to locate the seepage point exactly has been an open issue. By generalizing Darcy’s law applied solely to the saturated zone in an earth dam to the entire dam including the no-flow zone, a new variational inequality formulation is presented. The new formulation imposes a boundary condition of Signorini’s type on the potential seepage boundary and the seepage point turns out to be such a point that makes both inequalities in Signorini’s complementary condition become equalities. Singularity of the seepage point is accordingly eliminated. A strategy is developed for overcoming the mesh-dependency in the finite element implementation.     

On the behaviour near expiry for multi-dimensional American options

In this paper we analyse the behaviour, near expiry, of the free boundary appearing in the pricing of multi-dimensional American options in a financial market driven by a general multi-dimensional Ito diffusion. In particular, we prove regularity for the pricing function up to the terminal state and we establish a sufficient criteria for the conclusion that the optimal exercise boundary approaches the terminal state faster than parabolically.     

Power Penalty Method for a Linear Complementarity Problem Arising from American Option Valuation

In this paper, we present a power penalty function approach to the linear complementarity problem arising from pricing American options. The problem is first reformulated as a variational inequality problem; the resulting variational inequality problem is then transformed into a nonlinear parabolic partial differential equation (PDE) by adding a power penalty term. It is shown that the solution to the penalized equation converges to that of the variational inequality problem with an arbitrary order. This arbitrary-order convergence rate allows us to achieve the required accuracy of the solution with a small penalty parameter. A numerical scheme for solving the penalized nonlinear PDE is also proposed. Numerical results are given to illustrate the theoretical findings and to show the effectiveness and usefulness of the method. This work was partially supported by a research grant from the University of Western Australia and the Research Grant Council of Hong Kong, Grants PolyU BQ475 and PolyU BQ493.     

A Free Boundary Problem for an Elliptic–Parabolic System: Application to a Model of Tumor Growth

Abstract

In this article, we study a free boundary problem for a system of two partial differential equations, one parabolic and other elliptic. The system models the growth of a tumor with arbitrary initial shape. We establish the existence and uniqueness of a solution for some time interval. In the special case where we only have the elliptic equation, the problem coincides with the Hele–Shaw problem.