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Conditional expectation determination based on the J-process using Malliavin calculus applied to pricing American options |
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| Abstract: | The aim of our paper is to elaborate a theoretical methodology based on the Malliavin calculus to calculate the following conditional expectation ![/></span>(<i>P</i><sub><i>t</i></sub>(<i>X</i><sub><i>t</i></sub>)|(<i>X</i><sub><i>s</i></sub>)) for <i>s</i>≤<i>t</i> where the only state variable follows a J-process Jerbi Y. A new closed-form solution as an extension of the Black—Scholes formula allowing smile curve plotting. Quant Finance. 2013; Online First Article. doi:10.1080/14697688.2012.762458]. The theoretical results are applied to the American option pricing, consisting of an extension of the work of Bally et al. Pricing and hedging American options by Monte Carlo methods using a Malliavin calculus approach. Monte Carlo Methods Appl. 2005;11-2:97–133], as well as the J-process (with additional parameters λ and θ) is an extension of the Wiener process. The introduction of the aforesaid parameters induces skewness and kurtosis effects, i.e. smile curve allowing to fit with the reality of financial market. In his work Jerbi Jerbi Y. A new closed-form solution as an extension of the Black–-Scholes formula allowing smile curve plotting. Quant Finance. 2013; Online First Article. doi:10.1080/14697688.2012.762458] showed that the use of the J-process is equivalent to the use of a stochastic volatility model based on the Wiener process as in Heston's. The present work consists on extending this result to the American options. We studied the influence of the parameters λ and θ on the American option price and we find empirical results fitting with the options theory.</td>
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| Keywords: | conditional expectation Malliavin calculus J-process J-Law American option pricing smile curve | |