Article thumbnail

On the Solution of Complementarity Problems Arising in American Options Pricing

By Liming Feng, Vadim Linetsky, José Luis and Morales Jorge Nocedal


In the Black-Scholes-Merton model, as well as in more general stochastic models in finance, the price of an American option solves a parabolic variational inequality. When the variational inequality is discretized, one obtains a linear complementarity problem that must be solved at each time step. This paper presents an algorithm for the solution of these types of linear complementarity problems that is significantly faster than the methods currently used in practice. The new algorithm is a two-phase method that combines the active-set identification properties of the projected SOR iteration with the second-order acceleration of a (recursive) reduced-space phase. We show how to design the algorithm so that it exploits the structure of the linear complementarity problems arising in these financial applications and present numerical results that show the effectiveness of our approach

Topics: Key Words, American options pricing, linear complementarity, projected SOR method
Year: 2010
OAI identifier: oai:CiteSeerX.psu:
Provided by: CiteSeerX
Download PDF:
Sorry, we are unable to provide the full text but you may find it at the following location(s):
  • (external link)
  • http://www.ece.northwestern.ed... (external link)
  • Suggested articles

    To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.