Mark Broadie

Estimating Security Price Derivatives Using Simulation

Coauthor(s): Paul Glasserman.

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Abstract:
Simulation has proved to be a valuable tool for estimating security prices for which simple closed form solutions do not exist. In this paper we present two direct methods, a pathwise method and a likelihood ratio method, for estimating derivatives of security prices using simulation. With the direct methods, the information from a single simulation can be used to estimate multiple derivatives along with a security's price. The main advantage of the direct methods over re-simulation is increased computational speed. Another advantage is that the direct methods give unbiased estimates of derivatives, whereas the estimates obtained by re-simulation are biased. Computational results are given for both direct methods and comparisons are made to the standard method of re-simulation to estimate derivatives. The methods are illustrated for a path independent model (European options), a path dependent model (Asian options), and a model with multiple state variables (options with stochastic volatility).

Source: Management Science
Exact Citation:
Broadie, Mark, and Paul Glasserman. "Estimating Security Price Derivatives Using Simulation." Management Science 42, no. 2 (1996): 269-85.
Volume: 42
Number: 2
Pages: 269-85
Date: 1996