Ant colony optimization to price exotic options

  • Authors:

  • Sameer Kumar;Gitika Chadha;Ruppa K. Thulasiram;Parimala Thulasiraman

  • Affiliations:

  • Department of Computer Science, University of Manitoba, Winnipeg, Manitoba, Canda;Department of Computer Science, University of Manitoba, Winnipeg, Manitoba, Canda and Indian Institute of Technology, Kanpur, U.P., India;Department of Computer Science, University of Manitoba, Winnipeg, Manitoba, Canda;Department of Computer Science, University of Manitoba, Winnipeg, Manitoba, Canda

  • Venue:
  • CEC'09 Proceedings of the Eleventh conference on Congress on Evolutionary Computation
  • Year:
  • 2009

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Abstract

Option pricing is one of the challenging problems in finance. Finding the best time to exercise an option is a even more challenging problem, especially since the price of the underlying assets change rapidly. In this work, we study complex path dependent options by exploiting and extending a novel idea that we proposed earlier using a nature inspired meta-heuristic algorithm. Ant Colony Optimization (ACO). ACO has been used extensively in combinatorial optimization problems and recently in dynamic applications such as mobile ad-hoc networks where the objective is find a shortest path. However, in finance, especially in option pricing, we look for best time to exercise an option. Specifically, we use ants to decide on the best time to exercise so that the holder of the option contract will get the maximum benefit from his/her investment. Our algorithm and implementation suggests a better way to price options than traditional techniques such as Monte Carlo simulation or binomial lattice algorithm. Our pricing results compare very well with other techniques and at the same time the computational cost is reduced to a large extent.