An irregular grid approach for pricing high-dimensional American options

Authors:
S. J. Berridge;J. M. Schumacher
Affiliations:
Man Investments, Sugar Quay, Lower Thames Street, London EC3R 6DU, United Kingdom;Department of Econometrics and Operations Research and Center for Economic Research (CentER), Tilburg University, PO Box 90153, 5000 LE Tilburg, The Netherlands
Venue:
Journal of Computational and Applied Mathematics
Year:
2008

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Abstract

We propose and test a new method for pricing American options in a high-dimensional setting. The method is centered around the approximation of the associated complementarity problem on an irregular grid. We approximate the partial differential operator on this grid by appealing to the SDE representation of the underlying process and computing the root of the transition probability matrix of an approximating Markov chain. Experimental results in five-dimensions are presented for four different payoff functions.