Paper #543

Title:

On the robustness of least-squares Monte Carlo (LSM) for pricing American derivatives

Authors:

Manuel Moreno and Javier R. Navas

Date:

April 2001

Abstract:

This paper analyses the robustness of Least-Squares Monte Carlo, a technique recently proposed by Longstaff and Schwartz (2001) for pricing American options. This method is based on least-squares regressions in which the explanatory variables are certain polynomial functions. We analyze the impact of different basis functions on option prices. Numerical results for American put options provide evidence that a) this approach is very robust to the choice of different alternative polynomials and b) few basis functions are required. However, these conclusions are not reached when analyzing more complex derivatives.

Keywords:

Least-Squares Monte Carlo, option pricing, American options

JEL codes:

C15, C60, G13

Area of Research:

Finance and Accounting

Published in:

Review of Derivatives Research, 6 (2003), 2 (May), pp. 107-128

Download the paper in PDF format