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American Options on High Dividend Securities: A Numerical Investigation
- Source :
- Risks, Vol 7, Iss 2, p 59 (2019), Risks, Volume 7, Issue 2
- Publication Year :
- 2019
- Publisher :
- MDPI AG, 2019.
-
Abstract
- I document a sizeable bias that might arise when valuing out of the money American options via the Least Square Method proposed by Longstaff and Schwartz (2001). The key point of this algorithm is the regression-based estimate of the continuation value of an American option. If this regression is ill-posed, the procedure might deliver biased results. The price of the American option might even fall below the price of its European counterpart. For call options, this is likely to occur when the dividend yield of the underlying is high. This distortion is documented within the standard Black&ndash<br />Scholes&ndash<br />Merton model as well as within its most common extensions (the jump-diffusion, the stochastic volatility and the stochastic interest rates models). Finally, I propose two easy and effective workarounds that fix this distortion.
- Subjects :
- Strategy and Management
media_common.quotation_subject
Economics, Econometrics and Finance (miscellaneous)
binomial tree
Dividend yield
lcsh:HG8011-9999
lcsh:Insurance
derivatives pricing
Accounting
0502 economics and business
ddc:330
Econometrics
Economics
050207 economics
Distortion (economics)
Moneyness
American options
media_common
050208 finance
quadrinomial tree
Stochastic volatility
G13
05 social sciences
AMERICAN OPTIONS, BINOMIAL TREE, DERIVATIVES PRICING, LEAST SQUARE METHOD, QUADRINOMIAL TREE, STOCHASTIC INTEREST RATES
Interest rate
least square method
stochastic interest rates
Value (economics)
Dividend
Binomial options pricing model
Subjects
Details
- Language :
- English
- ISSN :
- 22279091
- Volume :
- 7
- Issue :
- 2
- Database :
- OpenAIRE
- Journal :
- Risks
- Accession number :
- edsair.doi.dedup.....567cd74afd23cb19ba59c572e488353e