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Decisions in Economics and Finance

, Volume 41, Issue 2, pp 399–426 | Cite as

Fast and accurate calculation of American option prices

  • Luca Vincenzo BallestraEmail author
Article
  • 38 Downloads

Abstract

We propose a very efficient numerical method to solve a nonlinear partial differential problem that is encountered in the pricing of American options. In particular, by using the front-fixing approach originally developed in Wu and Kwok (J Financ Eng 6:83–97, 1997) and Nielsen et al. (J Comput Finance 5:69–97, 2002) in conjunction with a suitable change of the time variable, a (nonlinear) partial differential problem is obtained which can be solved very efficiently by means of a finite difference scheme enhanced by repeated Richardson extrapolation. Numerical results are presented showing that the novel algorithm yields excellent results, and performs significantly better than a finite different method with Bermudan approximation.

Keywords

American option Front-fixing Richardson extrapolation Free-boundary problem 

JEL Classification

G13 C6 

Notes

Supplementary material

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Copyright information

© Associazione per la Matematica Applicata alle Scienze Economiche e Sociali (AMASES) 2018

Authors and Affiliations

  1. 1.Department of Statistical SciencesUniversity of BolognaBolognaItaly

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