Journal of Computational Finance

Quantization-based Bermudan option pricing in the foreign exchange world

Jean-Michel Fayolle, Vincent Lemaire, Thibaut Montes and Gilles Pagès

  • The paper presents two new numerical methods based on optimal quantization for the pricing of PRDC Bermudan options in a three-factor model where the FX rate and the domestic and foreign interest rates are stochastic.
  • L2 error estimates induced by the approximations are also provided.
  • Numerical experiments on market-based examples are conducted in order compare both methods.

This paper proposes two numerical solutions based on product optimal quantization for the pricing of Bermudan options on foreign exchange rates. More precisely, we consider the pricing of Bermudan power reverse dual currency options, taking into account stochastic domestic and foreign interest rates in addition to stochastic foreign exchange rates; we therefore consider a three-factor model. For the two numerical methods, we give an estimation of the L^2 error induced by the approximations and we illustrate the methods with market-based examples that highlight their speed.

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