Installment Option Valuation by Least Squares with Checking the Solution Convergence

Subject Areas : Journal of Investment Knowledge

Hamed Hamedinia ¹ , Mahdi Rezyati ²

1 - Ph.D. student, university of Tehran, Tehran, Iran
2 - Ph.D. student, university of Isfahan

Received: 2017-12-24 Accepted : 2018-03-06 Published : 2019-12-22

Keywords: Exotic Option, Installment Option, Least Square, Monte Carlo simulation,

Abstract :

An installment option is a European option in which the holder pays the option as a series of payments instead of paying all up-front. If all payments pay, the holder will be able to exercise the option at maturity time. However, the installment option will be terminated even if one installment is not paid. This study is divided into two sections. First, the importance of installment option is studied; the relationship between installment option and Venture Capital is explained; and it is studied how BLS model is failed to evaluate the installment option. As the exact evaluation of installment option is extremely complicated and usually intractable, Monte Carlo simulation and Least Squares (LS) have been applied to evaluate installment option. Second, the three optimum values, function type, number of base variables and number of simulated path, as important factors on this method are calculated. So, numerical valuation converges to exact solution.

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