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On the robustness of least-squares Monte Carlo (LSM) for pricing American derivatives
Moreno, Manuel; Navas, Javier R.
Universitat Pompeu Fabra. Departament d'Economia i Empresa
This paper analyses the robustness of Least-Squares Monte Carlo, a techniquerecently proposed by Longstaff and Schwartz (2001) for pricing Americanoptions. This method is based on least-squares regressions in which theexplanatory variables are certain polynomial functions. We analyze theimpact of different basis functions on option prices. Numerical resultsfor American put options provide evidence that a) this approach is veryrobust to the choice of different alternative polynomials and b) few basisfunctions are required. However, these conclusions are not reached whenanalyzing more complex derivatives.
Finance and Accounting
least-squares monte carlo
option pricing
american options
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