Empirical Tests of Canonical Nonparametric American Option Pricing Methods

Abstract

Alcock and Carmichael (2008) introduce a nonparametric method for pricing American style options that is derived from the canonical valuation developed by Stutzer (1996). While the statistical properties of this nonparametric pricing methodology have been studied in a controlled simulation environment, no study has yet examined the empirical validity of this method.We introduce an extension to this method that incorporates information contained in a small number of observed option prices. We explore the applicability of both the original method and our extension using a large sample of OEX American index options traded on the S&P100 index. While the Alcock and Carmichael (2008) method fails to outperform a traditional implied volatility based Black-Scholes valuation or a Binomial Tree approach, our extension generates signi cantly lower pricing errors and performs comparably well to the implied-volatility Black-Scholes pricing, in particular for out-of-the-money American put options.