The Valuation of American Options on Multiple Assets

The Valuation of American Options on Multiple Assets In this paper we provide valuation formulas for several types of American options on two or more assets. Our contribution is twofold. First, we characterize the optimal exercise regions and provide valuation formulas for a number of American option contracts on multiple underlying assets with convex payoff functions. Examples include options on the maximum of two assets, dual strike options, spread options, exchange options, options on the product and powers of the product, and options on the arithmetic average of two assets. Second, we derive results for American option contracts with nonconvex payoffs, such as American capped exchange options. For this option we explicitly identify the optimal exercise boundary and provide a decomposition of the price in terms of a capped exchange option with automatic exercise at the cap and an early exercise premium involving the benefits of exercising prior to reaching the cap. Besides generalizing the current literature on American option valuation our analysis has implications for the theory of investment under uncertainty. A specialization of one of our models also provides a new representation formula for an American capped option on a single underlying asset. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Mathematical Finance Wiley

The Valuation of American Options on Multiple Assets

Mathematical Finance, Volume 7 (3) – Jul 1, 1997

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Publisher
Wiley
Copyright
Blackwell Publishers Inc. 1997
ISSN
0960-1627
eISSN
1467-9965
DOI
10.1111/1467-9965.00032
Publisher site
See Article on Publisher Site

Abstract

In this paper we provide valuation formulas for several types of American options on two or more assets. Our contribution is twofold. First, we characterize the optimal exercise regions and provide valuation formulas for a number of American option contracts on multiple underlying assets with convex payoff functions. Examples include options on the maximum of two assets, dual strike options, spread options, exchange options, options on the product and powers of the product, and options on the arithmetic average of two assets. Second, we derive results for American option contracts with nonconvex payoffs, such as American capped exchange options. For this option we explicitly identify the optimal exercise boundary and provide a decomposition of the price in terms of a capped exchange option with automatic exercise at the cap and an early exercise premium involving the benefits of exercising prior to reaching the cap. Besides generalizing the current literature on American option valuation our analysis has implications for the theory of investment under uncertainty. A specialization of one of our models also provides a new representation formula for an American capped option on a single underlying asset.

Journal

Mathematical FinanceWiley

Published: Jul 1, 1997

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