American options: time-critical pricing

Time constraints can be binding for ‘heavy’ Monte Carlo calculations of risk analytics – value-at-risk, potential future exposure, credit valuation adjustment – in intraday risk monitoring, so fast approximations are sometimes preferred. Vladislav Boussyguine and Benoit Rodriguez show how existing semi-analytical pricing methods for American options can yield significant errors, and they propose a robust modification of Ju and Zhong’s method; its accuracy is compared with that of existing methods

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The size of option markets has reached astronomical levels, with the notional amount outstanding being dozens of trillions of dollars (see Bank for International Settlements 2014). A significant proportion of exchange-traded and over-the-counter options are American style, offering early an exercise opportunity to the holder.