TITLE:
The Effects of Negative Nominal Rates on the Pricing of American Calls: Some Theoretical and Numerical Insights
AUTHORS:
Alessia Cafferata, Pier Giuseppe Giribone, Marina Resta
KEYWORDS:
American Options, Quasi-Closed Formulas, Negative Interest Rates, Stochastic Trinomial Trees
JOURNAL NAME:
Modern Economy,
Vol.8 No.7,
July
13,
2017
ABSTRACT: The article investigates the
effects played on options pricing by negative risk-free rates when the
underlying is an equity with null dividends. In such anomalous conditions,
in fact, the fair value at early exercise of the American Call would not match
the value of the European Call with the same financial features. We originally
motivate this assumption with theoretical arguments. We then move to an
empirical investigation where we put at work some quasi-closed formulas for
pricing an American option and the stochastic trinomial trees algorithm. We
then draw the conclusion that from a numerical viewpoint, the bias between the
fair value of the American Call and the value of the corresponding. European
Call is mainly due to approximation errors, which can be mitigated when
Trinomial Stochastic Trees are used.