Truncation and acceleration of the Tian tree for the pricing of American put options |
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Authors: | Ting Chen |
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Institution: | Centre for Actuarial Studies, Department of Economics , University of Melbourne , VIC3010, Australia |
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Abstract: | We present a new method for truncating binomial trees based on using a tolerance to control truncation errors and apply it to the Tian tree together with acceleration techniques of smoothing and Richardson extrapolation. For both the current (based on standard deviations) and the new (based on tolerance) truncation methods, we test different truncation criteria, levels and replacement values to obtain the best combination for each required level of accuracy. We also provide numerical results demonstrating that the new method can be 50% faster than previously presented methods when pricing American put options in the Black–Scholes model. |
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Keywords: | American options Derivatives pricing Trees Truncations |
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