### Abstract

Sullivan (2000) used the Gauss-Legendre quadrature and the Chebyshev approximation to price the American put option. Starting from his work we construct a systematic way of pricing the Bermudan option with long-term maturity using numerical integrations. At each exercise time we approximate the option values multiplied by the discounted transition density function as a whole by the Chebyshev approximation. Then, at one step earlier exercise time we evaluate the option values by the exact integration of the Chebyshev approximation, i.e., by the summation of all the Chebyshev approximation values weighted by Clenshaw-Curtis weights at Chebyshev extremal nodes, which is known as the Clenshaw-Curtis quadrature. In this way we construct a recombining tree and using this recombining tree we price the Bermudan option. So we call this pricing method the recombining Clenshaw-Curtis quadrature. Using the same recombining tree we are also able to obtain Greeks easily. We search several different quadratures, construct recombining trees, and develop pricing methods. We compare the performance of various recombining quadratures with the benchmark Geske and Johnson (1984) and FDM method. Among all these pricing methods including the Geske and Johnson and FDM we find our recombining Clenshaw-Curtis and Gauss-Legendre-Lobatto quadrature are by far the most efficient and accurate in pricing the Bermudan option.

Original language | English |
---|---|

Pages (from-to) | 195-205 |

Number of pages | 11 |

Journal | Journal of Computational and Applied Mathematics |

Volume | 271 |

DOIs | |

Publication status | Published - 2014 Dec 1 |

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### All Science Journal Classification (ASJC) codes

- Computational Mathematics
- Applied Mathematics

### Cite this

*Journal of Computational and Applied Mathematics*,

*271*, 195-205. https://doi.org/10.1016/j.cam.2014.04.007

}

*Journal of Computational and Applied Mathematics*, vol. 271, pp. 195-205. https://doi.org/10.1016/j.cam.2014.04.007

**Efficient pricing of Bermudan options using recombining quadratures.** / Lim, Hyuncheul; Lee, Sungchul; Kim, Geonwoo.

Research output: Contribution to journal › Article

TY - JOUR

T1 - Efficient pricing of Bermudan options using recombining quadratures

AU - Lim, Hyuncheul

AU - Lee, Sungchul

AU - Kim, Geonwoo

PY - 2014/12/1

Y1 - 2014/12/1

N2 - Sullivan (2000) used the Gauss-Legendre quadrature and the Chebyshev approximation to price the American put option. Starting from his work we construct a systematic way of pricing the Bermudan option with long-term maturity using numerical integrations. At each exercise time we approximate the option values multiplied by the discounted transition density function as a whole by the Chebyshev approximation. Then, at one step earlier exercise time we evaluate the option values by the exact integration of the Chebyshev approximation, i.e., by the summation of all the Chebyshev approximation values weighted by Clenshaw-Curtis weights at Chebyshev extremal nodes, which is known as the Clenshaw-Curtis quadrature. In this way we construct a recombining tree and using this recombining tree we price the Bermudan option. So we call this pricing method the recombining Clenshaw-Curtis quadrature. Using the same recombining tree we are also able to obtain Greeks easily. We search several different quadratures, construct recombining trees, and develop pricing methods. We compare the performance of various recombining quadratures with the benchmark Geske and Johnson (1984) and FDM method. Among all these pricing methods including the Geske and Johnson and FDM we find our recombining Clenshaw-Curtis and Gauss-Legendre-Lobatto quadrature are by far the most efficient and accurate in pricing the Bermudan option.

AB - Sullivan (2000) used the Gauss-Legendre quadrature and the Chebyshev approximation to price the American put option. Starting from his work we construct a systematic way of pricing the Bermudan option with long-term maturity using numerical integrations. At each exercise time we approximate the option values multiplied by the discounted transition density function as a whole by the Chebyshev approximation. Then, at one step earlier exercise time we evaluate the option values by the exact integration of the Chebyshev approximation, i.e., by the summation of all the Chebyshev approximation values weighted by Clenshaw-Curtis weights at Chebyshev extremal nodes, which is known as the Clenshaw-Curtis quadrature. In this way we construct a recombining tree and using this recombining tree we price the Bermudan option. So we call this pricing method the recombining Clenshaw-Curtis quadrature. Using the same recombining tree we are also able to obtain Greeks easily. We search several different quadratures, construct recombining trees, and develop pricing methods. We compare the performance of various recombining quadratures with the benchmark Geske and Johnson (1984) and FDM method. Among all these pricing methods including the Geske and Johnson and FDM we find our recombining Clenshaw-Curtis and Gauss-Legendre-Lobatto quadrature are by far the most efficient and accurate in pricing the Bermudan option.

UR - http://www.scopus.com/inward/record.url?scp=84899815119&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=84899815119&partnerID=8YFLogxK

U2 - 10.1016/j.cam.2014.04.007

DO - 10.1016/j.cam.2014.04.007

M3 - Article

AN - SCOPUS:84899815119

VL - 271

SP - 195

EP - 205

JO - Journal of Computational and Applied Mathematics

JF - Journal of Computational and Applied Mathematics

SN - 0377-0427

ER -