The Monte Carlo Option Model

The History
The Monte Carlo Option Model was designed to compute the exact value of a particular option using Monte Carlo Methods, as termed by Stanislaw Ulam in the 1940’s.

Introduced by Phelim Boyle, this model was implemented for the first time in the year 1977 for the purpose of option pricing, which was applied for calculating the value of European options.

It was in 1996 that M. Broadie, along with P. Glasserman, discovered the exact process of applying the Monte Carlo Option Model for pricing Asian securities. A few years after, the model was also applied for determining the the values of American options, the process of which was discovered by E. S. Schwartz and F. A. Longstaff.
When it is Used
In mathematical finance, options with simple or normal features are valued through the straightforward Black-Scholes process. The Monte Carlo Option Model, however, is used to calculate the following types of options:

Options that relate to various sources of uncertainty, and calculating their values with other models is difficult.
Options that exist in the market but have very complicated features.
Arbitrage-free valuation of a definite derivative that consists of a large number of dimensions.

As the model requires a great deal of time for each analysis, it is used in limited situations.

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Last Updated on : 1st July 2013

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