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Open AccessArticle

American Options on High Dividend Securities: A Numerical Investigation

Department of Finance, Bocconi University, 20136 Milan, Italy
Risks 2019, 7(2), 59; https://doi.org/10.3390/risks7020059
Received: 28 February 2019 / Revised: 7 May 2019 / Accepted: 15 May 2019 / Published: 21 May 2019
(This article belongs to the Special Issue Applications of Stochastic Optimal Control to Economics and Finance)
I document a sizeable bias that might arise when valuing out of the money American options via the Least Square Method proposed by Longstaff and Schwartz (2001). The key point of this algorithm is the regression-based estimate of the continuation value of an American option. If this regression is ill-posed, the procedure might deliver biased results. The price of the American option might even fall below the price of its European counterpart. For call options, this is likely to occur when the dividend yield of the underlying is high. This distortion is documented within the standard Black–Scholes–Merton model as well as within its most common extensions (the jump-diffusion, the stochastic volatility and the stochastic interest rates models). Finally, I propose two easy and effective workarounds that fix this distortion. View Full-Text
Keywords: American options; least square method; derivatives pricing; binomial tree; stochastic interest rates; quadrinomial tree American options; least square method; derivatives pricing; binomial tree; stochastic interest rates; quadrinomial tree
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Rotondi, F. American Options on High Dividend Securities: A Numerical Investigation. Risks 2019, 7, 59.

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