An endogenous volatility approach to pricing and hedging call options with transaction costs

Standard delta hedging fails to exactly replicate a European call option in the presence of transaction costs. We study a pricing and hedging model similar to the delta hedging strategy with an endogenous volatility parameter for the calculation of delta over time. The endogenous volatility depends on both the transaction costs and the option strike prices. The optimal hedging volatility is calculated using the criterion of minimizing the weighted upside and downside replication errors. The endogenous volatility model with equal weights on the up and down replication errors yields an option premium close to the Leland [J. Finance, 1985 Leland, HE. 1985. Option pricing and replication with transaction costs. J. Finance, 40: 1283–1301. [Crossref], [Web of Science ®] , [Google Scholar], 40, 1283–1301] heuristic approach. The model with weights being the probabilities of the option's moneyness provides option prices closest to the actual prices. Option prices from the model are identical to the Black–Scholes option prices when transaction costs are zero. Data on S&P 500 index cash options from January to June 2008 illustrate the model.     

Optimal execution strategies in limit order books with general shape functions

We consider optimal execution strategies for block market orders placed in a limit order book (LOB). We build on the resilience model proposed by Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]) but allow for a general shape of the LOB defined via a given density function. Thus, we can allow for empirically observed LOB shapes and obtain a nonlinear price impact of market orders. We distinguish two possibilities for modelling the resilience of the LOB after a large market order: the exponential recovery of the number of limit orders, i.e. of the volume of the LOB, or the exponential recovery of the bid–ask spread. We consider both of these resilience modes and, in each case, derive explicit optimal execution strategies in discrete time. Applying our results to a block-shaped LOB, we obtain a new closed-form representation for the optimal strategy of a risk-neutral investor, which explicitly solves the recursive scheme given in Obizhaeva and Wang (2005 Obizhaeva, A and Wang, J. 2005. Optimal trading strategy and supply/demand dynamics, Preprint Available online at: http://www.rhsmith.umd.edu/faculty/obizhaeva/OW060408.pdf (accessed 16 February 2009)[Crossref] , [Google Scholar]). We also provide some evidence for the robustness of optimal strategies with respect to the choice of the shape function and the resilience-type.     

Industry cost of equity capital: European evidence for multifactor models

We estimate the costs of equity capital for 117 industries from 16 European countries employing the CAPM and 8 multifactor asset pricing models as well as a variety of different econometric techniques. In doing so, we extend previous research on cost of equity estimation in mainly two ways. First, our study involves European instead of US or UK industries, which are investigated in previous research, and we find that cost of equity estimates obtained from the CAPM or multifactor asset pricing models are as imprecise for European industries as for US and UK industries. Second, in addition to the CAPM, the Fama and French [1993 Fama, Eugene F., and Kenneth R. French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33: 3–56. doi: 10.1016/0304-405X(93)90023-5[Crossref], [Web of Science ®] , [Google Scholar]. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33: 3–56] three-factor model, and the Carhart [1997 Carhart, Mark M. 1997. “On Persistence in Mutual Fund Performance.” The Journal of Finance 52 (1): 57–82. doi: 10.1111/j.1540-6261.1997.tb03808.x[Crossref], [Web of Science ®] , [Google Scholar]. “On Persistence in Mutual Fund Performance.” The Journal of Finance 52 (1): 57–82] four-factor model, which are usually employed, our study includes six multifactor models that have not yet been examined on their ability to provide precise estimates of the costs of equity: the five-factor model of Fama and French [1993 Fama, Eugene F., and Kenneth R. French. 1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33: 3–56. doi: 10.1016/0304-405X(93)90023-5[Crossref], [Web of Science ®] , [Google Scholar]. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33: 3–56] as well as the multifactor models of Pástor and Stambaugh [2003 Pástor, Lubos, and Robert F. Stambaugh. 2003. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy 111 (3): 642–685. doi: 10.1086/374184[Crossref], [Web of Science ®] , [Google Scholar]. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy 111 (3): 642–685]; Campbell and Vuolteenaho [2004 Campbell, John Y., and Tuomo Vuolteenaho. 2004. “Bad Beta, Good Beta.” American Economic Review 94 (5): 1249–1275. doi: 10.1257/0002828043052240[Crossref], [Web of Science ®] , [Google Scholar]. “Bad Beta, Good Beta.” American Economic Review 94 (5): 1249–1275]; Hahn and Lee [2006 Hahn, Jaehoon, and Hangyong Lee. 2006. “Yield Spreads as Alternative Risk Factors for Size and Book-To-Market.” Journal of Financial &; Quantitative Analysis 41 (2): 245–269. doi: 10.1017/S0022109000002052[Crossref], [Web of Science ®] , [Google Scholar]. “Yield Spreads as Alternative Risk Factors for Size and Book-To-Market.” Journal of Financial &; Quantitative Analysis 41 (2): 245–269]; Petkova [2006 Petkova, Ralitsa. 2006. “Do the Fama–French Factors Proxy for Innovations in Predictive Variables?” The Journal of Finance 61 (2): 581–612. doi: 10.1111/j.1540-6261.2006.00849.x[Crossref], [Web of Science ®] , [Google Scholar]. “Do the Fama–French Factors Proxy for Innovations in Predictive Variables?” The Journal of Finance 61 (2): 581–612]; and Koijen, Lustig, and van Nieuwerburgh [2010 Koijen, Ralph S., Hanno N. Lustig, and Stijn G. van Nieuwerburgh. 2010. “The Cross-Section and Time-Series of Stock and Bond Returns.” Working Paper, University of Chicago, University of California at Los Angeles, New York University. [Google Scholar]. “The Cross-Section and Time-Series of Stock and Bond Returns.” Working Paper, University of Chicago, University of California at Los Angeles, New York University]. Our results suggest that these models provide even more imprecise cost of equity estimates. One main reason for these inaccurate estimates is the large temporal variation of the risk loadings on the non-traded factors in these models.     

Pricing and capital requirements for with profit contracts: modelling considerations

The aim of this paper is to provide an assessment of alternative frameworks for the fair valuation of life insurance contracts with a predominant financial component, in terms of impact on the market consistent price of the contracts, the embedded options, and the capital requirements for the insurer. In particular, we model the dynamics of the log-returns of the reference fund using the so-called Merton (1976 Merton, RC. 1976. Option pricing when underlying stock returns are discontinuous. J. Finan. Econ., : 125–144.  [Google Scholar]) process, which is given by the sum of an arithmetic Brownian motion and a compound Poisson process, and the Variance Gamma (VG) process introduced by Madan and Seneta (1990 Madan, DB and Seneta, E. 1990. The variance gamma (VG) model for share market returns. J. Bus., 63: 511–524. [Crossref], [Web of Science ®] , [Google Scholar]), and further refined by Madan and Milne (1991 Madan, DB and Milne, F. 1991. Option pricing with VG martingale components. Math. Finan., 1: 39–45. [Crossref] , [Google Scholar]) and Madan et al. (1998 Madan, DB, Carr, P and Chang, E. 1998. The variance gamma process and option pricing. Eur. Finan. Rev., 2: 79–105. [Crossref] , [Google Scholar]). We conclude that, although the choice of the market model does not affect significantly the market consistent price of the overall benefit due at maturity, the consequences of a model misspecification on the capital requirements are noticeable.     

Do emerging markets with consistent returns have better future performance?

Using monthly data for 25 emerging markets around the world, it is found that emerging markets with recently consistent stock returns tend to have future returns that continue in the same direction. The effects are long-lived for negative consistency, and imply that capital flows are much more sensitive to market downturns than market upturns. Additionally, the longer a market has had consistently negative (positive) stock returns, the more negative (positive) are future returns. These results serve as confirmation that the consistency effects of Grinblatt and Moskowitz [J. Finan. Econ., 2004 Grinblatt, M and Moskowitz, T. 2004. Predicting stock price movements from the pattern of past returns. J. Finan. Econ., 71: 541–579. [Crossref], [Web of Science ®] , [Google Scholar], forthcoming] and Watkins [J. Behav. Finan., 2003 Watkins, B. 2003. Riding the wave of investor sentiment: an analysis of consistency as a predictor of future stock returns. J. Behav. Finan., 4: 1–32.  [Google Scholar], 4, 1–32] exist in emerging markets around the world.     

A modified Corrado test for assessing abnormal security returns

Event studies typically use the methodology developed by Fama et al. [1969 Fama, E., Fisher, L., Jensen, M. and Roll, R. 1969. The adjustment of stock prices to new information. International Economic Review, 10(1): 1–21. [Crossref] , [Google Scholar]. The adjustment of stock prices to new information. International Economic Review 10, no. 1: 1–21] to segregate a stock's return into expected and unexpected components. Moreover, conventional practice assumes that abnormal returns evolve in terms of a normal distribution. There is, however, an increasing tendency for event studies to employ non-parametric testing procedures due to the mounting empirical evidence which shows that stock returns are incompatible with the normal distribution. This paper focuses on the widely used non-parametric ranking procedure developed by Corrado [1989 Corrado, C. 1989. A nonparametric test for abnormal security price performance in event studies. Journal of Financial Economics, 23(2): 385–95. [Crossref], [Web of Science ®] , [Google Scholar]. A nonparametric test for abnormal security price performance in event studies. Journal of Financial Economics 23, no. 2: 385–95] for assessing the significance of abnormal security returns. In particular, we develop a consistent estimator for the variance of the sum of ranks of the abnormal returns, and show how this leads to a more efficient test statistic (as well as to less cumbersome computational procedures) than the test originally proposed by Corrado (1989 Corrado, C. 1989. A nonparametric test for abnormal security price performance in event studies. Journal of Financial Economics, 23(2): 385–95. [Crossref], [Web of Science ®] , [Google Scholar]). We also use the theorem of Berry [1941 Berry, A. 1941. The accuracy of the Gaussian approximation to the sum of independent variates. Transactions of the American Mathematical Society, 49(1): 122–36. [Crossref] , [Google Scholar]. The accuracy of the Gaussian approximation to the sum of independent variates. Transactions of the American Mathematical Society 49, no. 1: 122–36] and Esseen [1945 Esseen, C. 1945. Fourier analysis of distribution functions: A mathematical study of the Laplace–Gaussian law. Acta Mathematica, 77(1): 1–125. [Crossref], [Web of Science ®] , [Google Scholar]. Fourier analysis of distribution functions: A mathematical study of the Laplace–Gaussian law. Acta Mathematica 77, no. 1: 1–125] to demonstrate how the distribution of the modified Corrado test statistic developed here asymptotically converges towards the normal distribution. This shows that describing the distributional properties of the sum of the ranks in terms of the normal distribution is highly problematic for small sample sizes and small event windows. In these circumstances, we show that a second-order Edgeworth expansion provides a good approximation to the actual probability distribution of the modified Corrado test statistic. The application of the modified Corrado test developed here is illustrated using data for the purchase and sale by UK directors of shares in their own companies.     

There's more to volatility than volume

It is widely believed that fluctuations in transaction volume, as reflected in the number of transactions and to a lesser extent their size, are the main cause of clustered volatility. Under this view bursts of rapid or slow price diffusion reflect bursts of frequent or less frequent trading, which cause both clustered volatility and heavy tails in price returns. We investigate this hypothesis using tick by tick data from the New York and London Stock Exchanges and show that only a small fraction of volatility fluctuations are explained in this manner. Clustered volatility is still very strong even if price changes are recorded on intervals in which the total transaction volume or number of transactions is held constant. In addition the distribution of price returns conditioned on volume or transaction frequency being held constant is similar to that in real time, making it clear that neither of these are the principal cause of heavy tails in price returns. We analyse recent results of Ane and Geman (2000 Ane, T and Geman, H. 2000. Order flow, transaction clock, and normality of asset returns. J. Finance, 55(5): 2259–2284. [Crossref], [Web of Science ®] , [Google Scholar]: J. Finance, 55, 2259–2284) and Gabaix et al. (2003 Gabaix, X, Gopikrishnan, P, Plerou, V and Stanley, H.E. 2003. A theory of power-law distributions in financial market fluctuations. Nature, 423: 267–270. [Crossref], [PubMed], [Web of Science ®] , [Google Scholar]: Nature, 423, 267–270), and discuss the reasons why their conclusions differ from ours. Based on a cross-sectional analysis we show that the long-memory of volatility is dominated by factors other than transaction frequency or total trading volume.     

Latin American stock markets’ volatility spillovers during the financial crises: a multivariate FIAPARCH-DCC framework

The main purpose of this paper is to analyse the volatility spillovers in Latin American emerging stock markets. A multivariate Fractionally Integrated Asymmetric Power ARCH model with dynamic conditional correlations of Engle (1982 Engle, R. F. 1982. Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica, 50: 987–1007. [Crossref], [Web of Science ®] , [Google Scholar]) with a Student-t distribution is employed. We examine whether considering for long memory and asymmetry in emerging stock markets behaviour may provide more insights into the volatility spillovers phenomenon. In this paper we select daily frequency stock indexes covering four emerging countries in Latin America for the period (January 1995–September 2009). Our results point out the importance of volatility spillovers in these countries. Moreover, long memory and asymmetry in emerging stock market dynamics seem to provide more insights into the transmission of volatility shocks. More interestingly, the analysis of the DCCEs behaviour over time via multivariate cointegration, vector error correction model and the Cholesky variance decomposition shows shifts behaviour around major Latin American financial crisis and recent subprime crisis. On the practical side, these results may be useful for international portfolio managers and Latin American stock market authorities.     

Political influences on the costs of banking crises in emerging market economies: testing the U-shaped veto player hypothesis

While there has been considerable research on the consequences of financial crises, there has been little empirical research on the possible effects of the role of domestic political institutions that influence a government's ability to implement crisis management policies. This paper investigates the impact of domestic institutions, characterized by a U-shaped veto player framework, on the output costs of banking crises. The analysis extends MacIntyre's qualitative study (2001 MacIntyre, Andrew. 2001. Institutions and investors: The politics of the economic crisis in Southeast Asia. International Organization, 55(1): 81–122. [Crossref], [Web of Science ®] , [Google Scholar]) of the relationship between veto players and policy risks in the Asian financial crises. For a large sample of emerging market economies, we find support for McIntyre's hypotheses that both too few and too many veto players are associated with greater costs of banking crises.     

Accounting for Variation in the Explanatory Power of the Psychometric Paradigm: The Effects of Aggregation and Focus

Most psychometric studies of risk perception have used data that have been averaged over participants prior to analysis. Such aggregation obscures variation among participants and inflates the magnitude of relationships between psychometric dimensions and dependent variables such as overall riskiness. However, most studies that have not averaged data over participants have also shifted the focus of analysis from differences among hazards to differences among participants. Hence, it is unclear whether observed reductions in the explanatory power of psychometric dimensions result from the change in the level of analysis or from the change in the focus of analysis. Following Willis et al.'s (2005 Willis, H. H., DeKay, M. L., Fischhoff, B. and Morgan, M. G. 2005. Aggregate, disaggregate, and hybrid analyses of ecological risk perceptions. Risk Analysis, 25(2): 405–428. [Crossref], [PubMed], [Web of Science ®] , [Google Scholar]) analysis of ecological risk perceptions, we unconfound these two variables in a study of risk perceptions in Santiago, Chile, although we use more traditional hazards, attributes, and statistical procedures. Results confirm that psychometric dimensions explain less variation in judgments of riskiness and acceptability at the disaggregate level than at the aggregate level. However, they also explain less variation when the focus of analysis is differences among participants rather than differences among hazards. These two effects appear to be similar in magnitude. A simple hybrid analysis economically represents variation among participants' judgments of hazards' riskiness by relating those judgments to a common set of psychometric dimensions from a traditional aggregate‐level analysis.     

Optimal time to sell a stock in the Black–Scholes model: comment on ‘Thou shalt buy and hold’, by A. Shiryaev,Z. Xu and X.Y. Zhou

We reconsider the problem of the optimal time to sell a stock studied by Shiryaev et al. (2008 Shiryaev, A, Xu, Z and Zhou, XY. 2008. Thou shalt buy and hold. Quant. Finan., 8: 765–776. [Taylor & Francis Online], [Web of Science ®] , [Google Scholar]) (following in this issue of Quantitative Finance) using path integral methods. These methods allow us to confirm the results obtained by these authors and extend them to the entire parameter region. We also obtain the full distribution of the time t_m at which the maximum of the price is reached for arbitrary values of the drift.     

Quango reform: the next steps?

The coalition government elected in 2010 in the UK pursued a programme of quango reform focused on reducing the number and expenditure of arm’s-length bodies, increasing transparency, improving accountability and maximizing efficiency and effectiveness. This paper revisits Flinders and Skelcher’s 2012 Flinders, M. and Skelcher, C. (2012), Shrinking the quango state: five challenges in reforming quangos. Public Money &; Management, 32, 5, pp. 327–334.[Taylor &; Francis Online], [Web of Science ®] , [Google Scholar] PMM paper ‘Shrinking the quango state: five challenges in reforming quangos’ to assess progress to date and consider future challenges. Drawing insights from the UK programme of quango reform, as well as similar developments in Ireland, the authors identify five new challenges for governments: regulating, managing, reconciling, co-ordinating and reflecting.     

International accounting books: Publishers' dream,authors' nightmare and educators' reality

Abstract

The emergence of International Financial Reporting Standards (IFRS) as the required convention for reporting to stock exchanges in the European Union (EU) and other important markets, together with the convergence programmes of major standard setters, has accelerated the reduction in differences in financial reporting between countries. The education of potential accountants would be expected to respond to these changes and, indeed, there is evidence that the teaching of accounting techniques now frequently draws on both IFRS and local GAAP. Perhaps a greater shift has been in the discipline of International Accounting (IA), which has moved from being an optional subject to being core to most programmes and an increasingly popular choice for more specialised degrees at both undergraduate and Master's levels. This article surveys the books that are available to support educators and learners in IA building on the analysis and classification of Laidler and Pallett (1998) Laidler, J. and Pallett, S. 1998. International accounting: a review of books available to support UK courses: a teaching note. Accounting Education: an International Journal, 7(1): 75–86. [Taylor &; Francis Online] , [Google Scholar] Accounting Education: an international journal, 7(1), pp. 75–86. A range of IA textbooks is examined in detail, along with a more general review of reference works. The analysis finds that there has been a growth in the number, breadth and depth of texts serving the IA market. Authors have fallen upon a number of devices in their battle to keep their materials up to date in this dynamic environment. Some of Laidler and Pallett's (1998) Laidler, J. and Pallett, S. 1998. International accounting: a review of books available to support UK courses: a teaching note. Accounting Education: an International Journal, 7(1): 75–86. [Taylor &; Francis Online] , [Google Scholar] criticisms of the writing and coverage of IA texts have been addressed, although not necessarily in the way that they envisaged. In spite of the growth of this section of publishers' catalogues, there remain a number of areas given scant coverage, notably enforcement and audit, and countries outside of the EU and US. The article concludes with recommendations for publishers, authors and educators to enhance the teaching of IA and the resources needed to support it.     

Physiological Age,Health Costs,and Their Interrelation

We demonstrate the impact of an observable health-related quantity on the evaluation of individual physiological ages by extending the phase-type aging model proposed by Lin and Liu in 2007 Lin, X. S., and X. Liu. 2007. Markov Aging Process and Phase-Type Law of Mortality. North American Actuarial Journal 11: 92–109.[Taylor &; Francis Online] , [Google Scholar]. In their model, an individual of a given calendar age has a determinable distribution of his or her physiological age. In our article, we use observable information to refine this distribution, thereby better connecting physiological age with the health of the individual. We illustrate our model using health cost data, and we investigate the impact of an observed health cost on the distribution of an individual’s physiological age. We also explore the impact on the expected present value of future health costs.     

Stochastic integrals driven by fractional Brownian motion and arbitrage: a tale of two integrals

Recent research suggests that fractional Brownian motion can be used to model the long-range dependence structure of the stock market. Fractional Brownian motion is not a semi-martingale and arbitrage opportunities do exist, however. Hu and Øksendal [Infin. Dimens. Anal., Quant. Probab. Relat. Top., 2003, 6, 1–32] and Elliott and van der Hoek [Math. Finan., 2003 Elliott, RJ and van de Hoek, J. 2003. A general fractional white noise theory applications to finance. Math. Finan., 13: 301–330. [Crossref], [Web of Science ®] , [Google Scholar], 13, 301–330] propose the use of the white noise calculus approach to circumvent this difficulty. Under such a setting, they argue that arbitrage does not exist in the fractional market. To unravel this discrepancy, we examine the definition of self-financing strategies used by these authors. By refining their definitions, a new notion of continuously rebalanced self-financing strategies, which is compatible with simple buy and hold strategies, is given. Under this definition, arbitrage opportunities do exist in fractional markets.     

On a risk model with dependence between interclaim arrivals and claim sizes

We consider an extension to the classical compound Poisson risk model for which the increments of the aggregate claim amount process are independent. In Albrecher and Teugels (2006 Albrecher, H. and Teugels, J. 2006. Exponential behavior in the presence of dependence in risk theory. Journal of Applied Probability, 43(1): 257–273. [Crossref], [Web of Science ®] , [Google Scholar]), an arbitrary dependence structure among the interclaim time and the subsequent claim size expressed through a copula is considered and they derived asymptotic results for both the finite and infinite-time ruin probabilities. In this paper, we consider a particular dependence structure among the interclaim time and the subsequent claim size and we derive the defective renewal equation satisfied by the expected discounted penalty function. Based on the compound geometric tail representation of the Laplace transform of the time to ruin, we also obtain an explicit expression for this Laplace transform for a large class of claim size distributions. The ruin probability being a special case of the Laplace transform of the time to ruin, explicit expressions are therefore obtained for this particular ruin related quantity. Finally, we measure the impact of the various dependence structures in the risk model on the ruin probability via the comparison of their Lundberg coefficients.     

Comparing Professions in UK and German-Speaking Management Accounting

This paper studies professional education in management accounting and the ways in which management accounting professions establish jurisdictional claims about management accounting work in the UK and German-speaking countries, respectively. We adopt a comparative approach drawing on the framework of systems of professions and the distinction between public, legal and workplace jurisdiction [Abbott, A. (1988 Abbott, A. (1988). The system of professions: An essay on the division of expert labor. Chicago, IL: University of Chicago Press.[Crossref] , [Google Scholar]). The system of professions: An essay on the division of expert labor. Chicago, IL: University of Chicago Press]. Our findings highlight some notable differences between the UK and German-speaking countries with respect to professional management accounting education, the jurisdictional claims that the professions make as well as the establishment and history of professional institutes for management accounting. Based on this analysis, the paper identifies a dilemma or at least a challenge for policy-makers with respect to balancing the need for a context-dependent model of professional education with a need for comparability and convergence.     

The Tourinho model: neglected nugget or a receding relic?

This article evaluates Tourinho's (1979b Tourinho, O. A.F. 1979b. “The valuation of reserves of natural resources: an option pricing approach”. Berkeley: University of California. PhD thesis [Google Scholar]) work as one of the earliest contributors to the real options literature. His model pioneered the application of risk neutrality to uncertain investments, but his originality of introducing an option-holding cost albeit to overcome the extraction paradox is rarely imitated. We claim that the combination of a convenience yield and an option-holding cost produces a more satisfying representation. Moreover, variations in the holding cost give rise to a host of investment decisions ranging from the standard real option solution for a zero-holding cost to a net present value solution for an infinite-holding cost. Not only does the holding cost mediate between these two poles, but it provides the option seller (usually a landowner or a government) with a policy instrument for influencing the extraction timing and thus the extraction profit of the option buyer. We derive the holding cost that optimizes the landowner's combined value of the option premium, holding costs and eventual royalties.     

Enhanced policy iteration for American options via scenario selection

Kolodko and Schoenmakers (2006 Kolodko, A and Schoenmakers, J. 2006. Iterative construction of the optimal Bermudan stopping time. Finan. Stochast., 10: 27–49. [Crossref], [Web of Science ®] , [Google Scholar]) and Bender and Schoenmakers (2006 Bender, C, Kolodko, A and Schoenmakers, J. 2006. Iterating cancelable snowballs and related exotics in a many-factor Libor model. Risk, September: 126–130.  [Google Scholar]) introduced a policy iteration that allows the achievement of a tight lower approximations of the price for early exercise options via a nested Monte Carlo simulation in a Markovian setting. In this paper we enhance the algorithm by a scenario selection method. It is demonstrated by numerical examples that the scenario selection can significantly reduce the number of inner simulations actually performed, and thus can greatly speed up the method (by up to a factor of 15 in some examples). Moreover, it is shown that the modified algorithm retains the desirable properties of the original, such as the monotone improvement property, termination after a finite number of iteration steps, and numerical stability.