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Estimating Security Price Derivatives Using Simulation

Author

Listed:
  • Mark Broadie

    (The Graduate School of Business, Columbia University, New York, New York 10027)

  • Paul Glasserman

    (The Graduate School of Business, Columbia University, New York, New York 10027)

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 resimulation is increased computational speed. Another advantage is that the direct methods give unbiased estimates of derivatives, whereas the estimates obtained by resimulation are biased. Computational results are given for both direct methods, and comparisons are made to the standard method of resimulation 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).

Suggested Citation

  • Mark Broadie & Paul Glasserman, 1996. "Estimating Security Price Derivatives Using Simulation," Management Science, INFORMS, vol. 42(2), pages 269-285, February.
    • Handle: RePEc:inm:ormnsc:v:42:y:1996:i:2:p:269-285
    DOI: 10.1287/mnsc.42.2.269
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