We develop a straightforward algorithm to price arithmetic average reset options with multiple reset dates in a Cox et al. (CRR) (1979)framework. The use of a lattice approach is due to its adaptability and flexibility in managing arithmetic average reset options, as already evidenced by Kim et al. (2003) . Their model is based on the Hull and White (1993) bucketing algorithm and uses an exogenous exponential function to manage the averaging feature, but their choice of fictitious values does not guarantee the algorithm’s convergence (cfr., Forsyth et al. (2002) ). We propose to overcome this drawback by selecting a limited number of trajectories among the ones reaching each node of the lattice, where we compute effective averages. In this way, the computational cost of the pricing problem is reduced, and the convergence of the discrete time model to the corresponding continuous time one is guaranteed.

On pricing arithmetic reset options with multiple reset dates in a lattice framework / Costabile, M; Massabo', Ivar; Russo, E.. - In: JOURNAL OF COMPUTATIONAL AND APPLIED MATHEMATICS. - ISSN 0377-0427. - 235(2011), pp. 55307-55325.

On pricing arithmetic reset options with multiple reset dates in a lattice framework

COSTABILE M;MASSABO', Ivar;
2011

Abstract

We develop a straightforward algorithm to price arithmetic average reset options with multiple reset dates in a Cox et al. (CRR) (1979)framework. The use of a lattice approach is due to its adaptability and flexibility in managing arithmetic average reset options, as already evidenced by Kim et al. (2003) . Their model is based on the Hull and White (1993) bucketing algorithm and uses an exogenous exponential function to manage the averaging feature, but their choice of fictitious values does not guarantee the algorithm’s convergence (cfr., Forsyth et al. (2002) ). We propose to overcome this drawback by selecting a limited number of trajectories among the ones reaching each node of the lattice, where we compute effective averages. In this way, the computational cost of the pricing problem is reduced, and the convergence of the discrete time model to the corresponding continuous time one is guaranteed.
Reset options. ; Binomial algorithms. ; Discrete time models.
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Utilizza questo identificativo per citare o creare un link a questo documento: http://hdl.handle.net/20.500.11770/137099
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