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).

Abstract:

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

Download the full text E2016010.pdf