Journal of Financial and Quantitative Analysis Vol. 37 No. 1 2002

Analytical Upper Bounds for American Option Prices

Ren-Raw Chen¹; Shih-Kuo Yeh²

¹ Rutgers, The State University of New Jersey · ² National Kaohsiung First University of Science and Technology

Abstract

American options require numerical methods, namely lattice models, to provide accurate price estimates. The computations can become expensive when more than one state variable is involved. Analytical upper bounds can therefore provide a useful guideline for how high American values can reach. In this paper, we derive analytical (closed-form) upper bounds for American option prices under stochastic interest rates, stochastic volatility, and jumps where American option prices are difficult to compute with accuracy. In a stochastic volatility model (Heston (1993) and Scott (1997)) that has two random factors, we demonstrate that the upper bound only takes a very small fraction of the time that the American option needs to compute.

DOI

10.2307/3594997

Volume

37

Issue

1

Pages

117

Sources

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