Numerical valuation of Bermudan basket options via partial differential equations

Abstract

We study the principal component analysis based approach introduced by Reisinger & Wittum [1] and the comonotonic approach considered by Hanbali & Linders [2] for the approximation of American basket option values via multidimensional partial differential complementarity problems (PDCPs). Both approximation approaches require the solution of just a limited number of low-dimensional PDCPs. It is demonstrated by ample numerical experiments that they define approximations that lie close to each other. Next, an efficient discretisation of the pertinent PDCPs is presented that leads to a favourable convergence behaviour.