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| Type | Working Paper |
| Scope | Discipline-based scholarship |
| Title | An Approximation of an Equivalent European Payoff for the American Put Option |
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| Institution | University of Zurich |
| Series Name | SSRN |
| Number | 2892152 |
| Number of Pages | 12 |
| Date | 2017 |
| Abstract Text | Is the American put option in the Black-Scholes model simply an incognito European one? In this paper, we develop a numerical procedure, in the context of the Black-Scholes model, to approximate the payoff of a European type option that generates prices that are equal to the prices of the American put option in the continuation region. The resulting equivalent European payoff is a sum of power payoffs and therefore the price and the hedging indicators can be computed in closed form. For a given set of model parameters (interest rate, dividend rate and volatility) the computation of the equivalent European payoff reduces to solving a linear optimization problem. We conduct a numerical experiment spanning a wide range of model parameters and contract characteristics and, overall, the method produces American option prices with a relative RMSE less than 0.01% compared to a benchmark. |
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