Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/257897 
Year of Publication: 
2019
Citation: 
[Journal:] Risks [ISSN:] 2227-9091 [Volume:] 7 [Issue:] 2 [Article No.:] 59 [Publisher:] MDPI [Place:] Basel [Year:] 2019 [Pages:] 1-20
Publisher: 
MDPI, Basel
Abstract: 
I document a sizeable bias that might arise when valuing out of the money American options via the Least Square Method proposed by Longstaff and Schwartz (2001). The key point of this algorithm is the regression-based estimate of the continuation value of an American option. If this regression is ill-posed, the procedure might deliver biased results. The price of the American option might even fall below the price of its European counterpart. For call options, this is likely to occur when the dividend yield of the underlying is high. This distortion is documented within the standard Black-Scholes-Merton model as well as within its most common extensions (the jump-diffusion, the stochastic volatility and the stochastic interest rates models). Finally, I propose two easy and effective workarounds that fix this distortion.
Subjects: 
American options
least square method
derivatives pricing
binomial tree
stochastic interest rates
quadrinomial tree
JEL: 
G13
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article
Appears in Collections:

Files in This Item:
File
Size





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.