Pricing American Options under Stochastic Volatility and Stochastic Interest Rates

Alexey N. Medvedev, O. Scaillet
2009 Social Science Research Network  
In this paper we introduce a new analytical approach to pricing American options. We use an explicit and intuitively appealing proxy for the exercise rule, and derive tractable pricing formulas using a short-maturity asymptotic expansion. Numerical experiments show that the analytical approximation is fast and accurate for options with time-to-maturity up to several years under typical model parameters. In the Black-Scholes case the approximation is as precise as a binomial tree with several
more » ... ree with several hundred steps with the speed of a 25-step tree. The main advantage of our approach lies in its application to a three-factor model with stochastic volatility and stochastic interest rates while keeping computational time low.
doi:10.2139/ssrn.966055 fatcat:4foiydkzozdmnac3tdgke3hnki