TRUE MARTINGALES FOR UPPER BOUNDS ON BERMUDAN OPTION PRICES UNDER JUMP-DIFFUSION PROCESSES

Fast pricing of American-style options has been a difficult problem since it was first introduced to financial markets in 1970s, especially when the underlying stocks ’ prices follow some jump-diffusion processes. In this paper, we propose a new algorithm to generate tight upper bounds on the Bermudan option price without nested simulation, under the jump-diffusion setting. By exploiting the martingale representation theorem for jump processes on the dual martingale, we are able to construct a martingale approximation that preserves the martingale property. The resulting upper bound estimator avoids the nested Monte Carlo simulation suffered by the original primal-dual algorithm, therefore significantly improves the computational efficiency. Theoretical analysis is provided to guarantee the quality of the martingale approximation. Numerical experiments are conducted to verify the efficiency of our proposed algorithm.