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Risks 2015, 3(2), 103-111; doi:10.3390/risks3020103

Rationality Parameter for Exercising American Put

Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, 2100 Copenhagen, Denmark
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Authors to whom correspondence should be addressed.
Academic Editor: Mogens Steffensen
Received: 23 February 2015 / Revised: 20 April 2015 / Accepted: 12 May 2015 / Published: 20 May 2015
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Abstract

In this paper, irrational exercise behavior of the buyer of an American put is characterized by a single parameter. We model irrational exercise rules as the first jump time of a point processes with stochastic intensity. By the rationality parameter, we parameterize a family of stochastic intensities that depends on the value of the put itself. We present a probabilistic proof that the value of the American put using the irrational exercise rule converges to the arbitrage-free price as the rationality parameter converges to infinity. Another application of this result is the penalty method for approximating the price of an American put. View Full-Text
Keywords: behavioral modeling; irrational exercise rule; partial differential equation; penalty method behavioral modeling; irrational exercise rule; partial differential equation; penalty method
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).

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Gad, K.S.T.; Pedersen, J.L. Rationality Parameter for Exercising American Put. Risks 2015, 3, 103-111.

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