Pricing American Options Using a Nonparametric Entropy Approach
This paper studies the pricing problem of American options using a nonparametric entropy approach. First, we derive a general expression for recovering the risk-neutral moments of underlying asset return and then incorporate them into the maximum entropy framework as constraints. Second, by solving...
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| Main Authors: | , |
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| Format: | Article |
| Language: | English |
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Wiley
2014-01-01
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| Series: | Discrete Dynamics in Nature and Society |
| Online Access: | http://dx.doi.org/10.1155/2014/369795 |
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| _version_ | 1832556630251667456 |
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| author | Xisheng Yu Li Yang |
| author_facet | Xisheng Yu Li Yang |
| author_sort | Xisheng Yu |
| collection | DOAJ |
| description | This paper studies the pricing problem of American options using a nonparametric
entropy approach. First, we derive a general expression for recovering the risk-neutral
moments of underlying asset return and then incorporate them into the maximum entropy framework as constraints. Second, by solving this constrained entropy problem,
we obtain a discrete risk-neutral (martingale) distribution as the unique pricing measure. Third, the optimal exercise strategies are achieved via the least-squares Monte
Carlo algorithm and consequently the pricing algorithm of American options is obtained. Finally, we conduct the comparative analysis based on simulations and IBM
option contracts. The results demonstrate that this nonparametric entropy approach
yields reasonably accurate prices for American options and produces smaller pricing
errors compared to other competing methods. |
| format | Article |
| id | doaj-art-adb888f867d9430f8cdec6ffcadf4420 |
| institution | Kabale University |
| issn | 1026-0226 1607-887X |
| language | English |
| publishDate | 2014-01-01 |
| publisher | Wiley |
| record_format | Article |
| series | Discrete Dynamics in Nature and Society |
| spelling | doaj-art-adb888f867d9430f8cdec6ffcadf44202025-02-03T05:44:55ZengWileyDiscrete Dynamics in Nature and Society1026-02261607-887X2014-01-01201410.1155/2014/369795369795Pricing American Options Using a Nonparametric Entropy ApproachXisheng Yu0Li Yang1School of Economic Mathematics, Southwestern University of Finance and Economics, Chengdu 611130, ChinaAustralian School of Business, University of New South Wales, NSW 2052, AustraliaThis paper studies the pricing problem of American options using a nonparametric entropy approach. First, we derive a general expression for recovering the risk-neutral moments of underlying asset return and then incorporate them into the maximum entropy framework as constraints. Second, by solving this constrained entropy problem, we obtain a discrete risk-neutral (martingale) distribution as the unique pricing measure. Third, the optimal exercise strategies are achieved via the least-squares Monte Carlo algorithm and consequently the pricing algorithm of American options is obtained. Finally, we conduct the comparative analysis based on simulations and IBM option contracts. The results demonstrate that this nonparametric entropy approach yields reasonably accurate prices for American options and produces smaller pricing errors compared to other competing methods.http://dx.doi.org/10.1155/2014/369795 |
| spellingShingle | Xisheng Yu Li Yang Pricing American Options Using a Nonparametric Entropy Approach Discrete Dynamics in Nature and Society |
| title | Pricing American Options Using a Nonparametric Entropy Approach |
| title_full | Pricing American Options Using a Nonparametric Entropy Approach |
| title_fullStr | Pricing American Options Using a Nonparametric Entropy Approach |
| title_full_unstemmed | Pricing American Options Using a Nonparametric Entropy Approach |
| title_short | Pricing American Options Using a Nonparametric Entropy Approach |
| title_sort | pricing american options using a nonparametric entropy approach |
| url | http://dx.doi.org/10.1155/2014/369795 |
| work_keys_str_mv | AT xishengyu pricingamericanoptionsusinganonparametricentropyapproach AT liyang pricingamericanoptionsusinganonparametricentropyapproach |