Finite differences discrete dividends American options
Issue Date:
2017
Publisher:
Institute of Mathematics and Informatics at the Bulgarian Academy of Sciences
Citation:
Pliska Studia Mathematica Bulgarica, Vol. 27, No 1, (2017), 37p-46p
Abstract:
Dividends are a detail of financial instruments pricing which is often being oversimplified. However, companies do declare (and pay out) flows which can be significant. In this paper we briefly review some known approaches to this topic. We analyse a few known drawbacks with application to American option pricing. Due to the fact that these options rely on numerical methods for their pricing, applying discrete dividends to the chosen approach may affect the solution quality. As we will show shortly, for some methods there are flaws affecting positivity and smoothness of the numerical solution while others are too computationally heavy. We find that applying discrete dividends to an exponentially fitted scheme (the Duffy scheme) overcomes these problems and we manage to obtain a smooth and sensible solution. 2010 Mathematics Subject Classification: 35K10, 65N06, 91G60, 62P05.
