An FFT-network for Lévy option pricing

This paper develops a simple network approach to American exotic option valuation under Lévy processes using the fast Fourier transform (FFT). The forward shooting grid (FSG) technique of the lattice approach is then generalized to expand the FFT-network to accommodate path-dependent variables. This...

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Bibliographic Details
Published in:Journal of banking & finance 2011-04, Vol.35 (4), p.988-999
Main Authors: Wong, Hoi Ying, Guan, Peiqiu
Format: Article
Language:English
Subjects:
American options
American options FFT-network Levy processes Exotic options
Asia
Asset pricing
Exotic options
FFT-network
Fourier transforms
Levy processes
Lévy processes
Mathematical models
Option pricing
Put & call options
Securities prices
Statistical models
Stock exchange
Stock exchange expectations
Stock prices
Studies
U.S.A
Valuation methods
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Summary:This paper develops a simple network approach to American exotic option valuation under Lévy processes using the fast Fourier transform (FFT). The forward shooting grid (FSG) technique of the lattice approach is then generalized to expand the FFT-network to accommodate path-dependent variables. This network pricing approach is applicable to all Lévy processes for which the characteristic function is readily available. In other words, the log-value of the underlying asset can follow finite-activity or infinite-activity Lévy processes. With the powerful computation of FFT, the proposed network has a negligible additional computational burden compared to the binomial tree approach. The early exercise policy and option values in the continuation region are determined in a way very similar to that of the lattice approach. Numerical examples using American-style barrier, lookback, and Asian options demonstrate that the FFT-network is accurate and efficient.
ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2010.09.014