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Empirical tests of canonical nonparametric American option‐pricing methods
Author(s) -
Alcock Jamie,
Auerswald Diana
Publication year - 2010
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.20421
Subject(s) - binomial options pricing model , nonparametric statistics , valuation of options , trinomial tree , econometrics , valuation (finance) , black–scholes model , futures contract , economics , implied volatility , moneyness , extension (predicate logic) , volatility (finance) , mathematics , actuarial science , financial economics , computer science , finance , programming language
Alcock and Carmichael (2008, The Journal of Futures Markets , 28, 717–748) introduce a nonparametric method for pricing American‐style options, that is derived from the canonical valuation developed by Stutzer (1996, The Journal of Finance , 51, 1633–1652). Although the statistical properties of this nonparametric pricing methodology have been studied in a controlled simulation environment, no study has yet examined the empirical validity of this method. We introduce an extension to this method that incorporates information contained in a small number of observed option prices. We explore the applicability of both the original method and our extension using a large sample of OEX American index options traded on the S&P100 index. Although the Alcock and Carmichael method fails to outperform a traditional implied‐volatility‐based Black–Scholes valuation or a binomial tree approach, our extension generates significantly lower pricing errors and performs comparably well to the implied‐volatility Black–Scholes pricing, in particular for out‐of‐the‐money American put options. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:509–532, 2010