An Integral Equation Method with High-Order Collocation Implementations for Pricing American Put Options

Jingtang Ma, Kaili Xiang, Yingjun Jiang

Abstract


The aim of this paper is to solve a free boundary problem arising in pricing American put options. It is known that the free boundary (optimal exercise boundary) satisfies a “nonstandard” Volterra integral equation. This Volterra integral equation is resolved by a high-order collocation method based on graded meshes. With the computed free boundary, a Black-Scholes equation for pricing the American put options is solved by a moving mesh method. Numerical examples are provided to confirm the efficiency of the approach.


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International Journal of Economics and Finance  ISSN  1916-971X (Print) ISSN  1916-9728 (Online)

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