rationality parameter for exercising american put

rationality parameter for exercising american put

;Kamille Sofie Tågholt Gad;Jesper Lund Pedersen
world neurosurgery 2015 Vol. 3 pp. 103-111
108
gad2015risksrationality

Abstract

In this paper, irrational exercise behavior of the buyer of an American put is characterized by a single parameter. We model irrational exercise rules as the first jump time of a point processes with stochastic intensity. By the rationality parameter, we parameterize a family of stochastic intensities that depends on the value of the put itself. We present a probabilistic proof that the value of the American put using the irrational exercise rule converges to the arbitrage-free price as the rationality parameter converges to infinity. Another application of this result is the penalty method for approximating the price of an American put.

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235458
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