Comput Econ https://doi.org/10.1007/s10614-018-9826-5 Developing a Risk-Based Approach for American Basket Option Pricing 1 1 Ehsan Hajizadeh · Masoud Mahootchi Accepted: 28 May 2018 © Springer Science+Business Media, LLC, part of Springer Nature 2018 Abstract Options are one of the important ﬁnancial contracts for reducing the risk of investors. Many active practitioners in the ﬁnancial markets really believe that mispricing or incorrect valuation of these securities would be the main reason of collapse of some ﬁnancial institutions. The complexity of option pricing/valuation, especially in the case of American basket options, as high dimensional options, has motivated many researchers to develop numerical and simulation-based models. In this paper, a new simulation-based approach for pricing/valuation of American bas- ket option with risk consideration is proposed. Having the prices obtained through Longstaff–Schwartz methodology, which is based on Approximate Dynamic Pro- gramming as a risk-neutral approach, we propose a new approach for pricing the American basket option according to the worst-case (pessimistic/risk-averse) and the best-case (optimistic/risk-taking) scenarios. Furthermore, for scenarios generation, we use a Monte Carlo simulation technique using a t-student copula-GARCH method and Extreme Value Theory to handle the nonlinearity of dependencies between variables. To verify the computational efﬁciency and the accuracy of
Computational Economics – Springer Journals
Published: Jun 5, 2018
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