A numerical study of the utility-indifference approach for pricing American options. (1st September 2020)

• Record Type: Journal Article
• Authors: Yan, Dong; Zhu, Song-Ping; Lu, Xiaoping
• Is Part Of: Computers & mathematics with applications. Volume 80:issue 5(2020)
• Page Start: 894
• Page End: 905
• Publication Date: 2020-09-01
• Subjects: Option pricing -- Utility-based approach -- Constant volatility -- Hamilton–Jacobi–Bellman equation -- Finite differences; Electronic data processing -- Periodicals; Mathematics -- Data processing -- Periodicals; 510.28541
• DOI: 10.1016/j.camwa.2020.05.007
• Languages: English
• ISSNs: 0898-1221

Abstract

Abstract: Utility-indifference approach is a useful approach to be adopted for pricing financial derivatives in an incomplete market and is an ongoing hot research topic in quantitative finance. One interesting question associated with this approach is whether or not it renders to the same option prices, degenerately, when the market becomes infinitesimally close to a complete market. The answer for such a question has been provided for European-style options as there is a well-documented theoretical proof in Davis et al. (1993). However, a theoretical proof for the case of pricing American-style options is unavailable at this stage and the answer for this question must be at least numerically confirmed before it can be comfortably used to price American-style options in incomplete markets. The contribution of this paper is to provide such a numerical verification.