Optimal exercise of Russian options in the binomial model

R. W. Chen, B. Rosenberg

Research output: Chapter in Book/Report/Conference proceedingConference contribution

Abstract

The Russian option is a two-party contract which creates a liability for the option seller to pay the option buyer an amount equal to the maximum price attained by a security over a specific time period, discounted for the option's age. The Russian option was proposed by Shepp and Shiryaev. Kramkov and Shiryaev first examined the option in the binomial model. We improve upon their results and give a near-optimal algorithm for price determination. Specifically, we prove that the optimal exercising boundary is monotonic and give an O(N) dynamic programming algorithm to construct the boundary, where N is the option expiration time. The algorithm also computes the option's value at time zero in time O(N) and the value at all of the O(N3) nodes in the binomial model in time O(N2).

Original languageEnglish (US)
Title of host publicationComputational Finance and its Applications II
Pages171-181
Number of pages11
DOIs
StatePublished - Dec 1 2006
Event2nd International Conference on Computational Finance and its Applications, COMPUTATIONAL FINANCE 2006, CF06 - London, United Kingdom
Duration: Jun 27 2006Jun 29 2006

Publication series

NameWIT Transactions on Modelling and Simulation
Volume43
ISSN (Print)1743-355X

Other

Other2nd International Conference on Computational Finance and its Applications, COMPUTATIONAL FINANCE 2006, CF06
CountryUnited Kingdom
CityLondon
Period6/27/066/29/06

Keywords

  • Binomial model
  • Dynamic programming
  • Russian option

ASJC Scopus subject areas

  • Modeling and Simulation
  • Computational Mathematics

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    Chen, R. W., & Rosenberg, B. (2006). Optimal exercise of Russian options in the binomial model. In Computational Finance and its Applications II (pp. 171-181). (WIT Transactions on Modelling and Simulation; Vol. 43). https://doi.org/10.2495/CF060171