No.E2016010 September 2016
Wenbo Wu 1 、Yong Li 2 、 Zhuo Huang 3
(1,2, Hanqing Advanced Institute of Economics and Finance, Renmin University of China, Beijing, 100872, China. 3. National School of Development, Peking University, Beijing, 100871, China).
In this paper, we extend the quadrature method of Andricopoulos, Widdicks, Duck, and Newton (2003) to price American options under jump-diffusion models in an efficient and accurate manner. We approximate American options by Bermudan options, which can be exercised on hundreds of dates, and implement a recursive process in a simple matrix form based on suggested static lattice points. In addition, to show the universality, we apply the proposed approach to the Gaussian jump model, the double-exponential jump model, and the lognormal jump-extended CEV model. To demonstrate the advantages of our method, we compare it in detail with other popular methods for pricing American options under jump-diffusion models.
JEL classification: G12, C60
Keywords: Quadrature, Jump-diffusion model, American option, Static grid