American Option Valuation: Implied Calibration of GARCH Pricing-Models

Abstract: This article analyzes the issue of American option valuation when the underlying exhibits a GARCH-type volatility process. We propose the usage of Rubinstein's Edgeworth binomial tree (EBT) in contrast to simulation-based methods being considered in previous studies. The EBT-based valuation approach makes an implied calibration of the pricing model feasible. By empirically analyzing the pricing performance of American index and equity options, we illustrate the superiority of the proposed approach.

Published on 2nd September 2011
Authors Michael Weber, Marcel Prokopczuk
Series Reference 2010-02

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