Foresight Bias and Suboptimality Correction in Monte—Carlo Pricing of Options with Early Exercise
We provide a definition and an analytic formula for the so called foresight bias that may appear in the Monte—Carlo pricing of Bermudan and compound options if the exercise criteria is calculated by the same Monte—Carlo simulation as the exercise values. The analytical correction for the foresight bias is then applied to the Monte—Carlo pricing of a Bermudan option (Bellman's principle), resulting in better prices, especially for very low number of paths.
KeywordsConditional Expectation Risk Free Asset Early Exercise Optimal Exercise Price Measure
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- 1.Fries, C.P.: Foresight Bias and Suboptimality Correction in Monte-Carlo Pricing of Options with Early Exercise: Classification, Calculation and Removal (2005). http://www.christian-fries.de/finmath/foresightbias
- 2.Fries, C.P.: Mathematical Finance. Theory, Modeling, Implementation. Lectures Notes. Frankfurt am Main (2006). http://www.christian-fries.de/finmath/book