Pricing American Asian options with higher moments in the underlying distribution

Abstract

We develop a modified Edgeworth binomial model with higher moment considereation for pricing American Asian options. With lognormal underlying distribution for benchmark comparison, Our algorithm is as precise as that of Chalasani et it. [P. Chalasani., S. Jha, F. Egriboyun, A. Varikooty, A refined binomial lattice for American Asian options, Rev. Derivatives Res. 3 (1) (1999) 85-105] if the number of the time steps increases. If the underlying distribution displays negative skewness and leptokurtosis as often observed for stock index returns, Our estimates can work better than those in Chalasani et al. 111. Chalasani, S. Jha, F. Egriboyun, A. Varikooty, A refined biomial lattice for pricing American Asian options, Rev. Derivatives Res. 3 (1) (1999) 85-105] and are very similar to the benchmarks in Hull and White [J. Hull A. White, Efficient procedures for valuing European Our modified and American path-dependent options. J. Derivatives I (Fall) (1993) 21-31]. The numerical analysis shows that Edgeworth binomial model can value American Asian options with greater accuracy and speed given higher moments in their underlying distribution. (C) 2008 Elsevier B.V. All rights reserved.