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American option pricing under GARCH with non-normal innovations

  • Jean-Guy Simonato
Research Article
  • 5 Downloads

Abstract

As it is well known from the time-series literature, GARCH processes with non-normal shocks provide better descriptions of stock returns than GARCH processes with normal shocks. However, in the derivatives literature, American option pricing algorithms under GARCH are typically designed to deal with normal shocks. We thus develop here an approach capable of pricing American options with non-normal shocks. The approach uses an equilibrium pricing model with shocks characterized by a Johnson \(S_{u}\) distribution and a simple algorithm inspired from the quadrature approaches recently proposed in the option pricing literature. Numerical experiments calibrated to stock index return data show that this method provides accurate option prices under GARCH for non-normal and normal cases.

Keywords

American options GARCH Johnson distribution Quadrature 

JEL Classification

C63 G13 

Notes

Acknowledgements

This research was supported by the Social Sciences and Humanities Research Council of Canada. I would like to thank Lynn Mailloux for helpful comments

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Department of FinanceHEC MontréalMontréalCanada

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