fOptions (version 3042.86)

MonteCarloOptions: Monte Carlo Valuation of Options

Description

A collection and description of functions to valuate options by Monte Carlo methods. The functions include beside the main Monte Carlo Simulator, example functions to generate Monte Carlo price paths and to compute Monte Carlo price payoffs.

The functions are:

sobolInnovations	Example for scrambled Sobol innovations,
wienerPath	Example for a Wiener price path,
plainVanillaPayoff	Example for the plain vanilla option's payoff,
arithmeticAsianPayoff	Example for the arithmetic Asian option's payoff,

Usage

MonteCarloOption(delta.t, pathLength, mcSteps, mcLoops, init = TRUE, 
    innovations.gen, path.gen, payoff.calc, antithetic = TRUE, 
    standardization = FALSE, trace = TRUE, …)

Arguments

antithetic

a logical flag, should antithetic variates be used? By default TRUE.

delta.t

the time step interval measured as a fraction of one year, by default one day, i.e. delta.t=1/360.

init

a logical flag, should the random number generator be initialized? By default TRUE.

innovations.gen

a user defined function to generate the innovations, this can be the normal random number generator rnorm.pseudo with mean zero and variance one. For the usage of low discrepancy sequences alternativey rnorm.halton and rnorm.sobol can be called. The generator must deliver a normalized matrix of innovations with dimension given by the number of Monte Carlo steps and the path length. The first three arguments of the generator are the the number of Monte Carlo steps mcSteps, the path length pathLength and the initialization flag init. Optional arguments can be passed through the argument …, e.g. the type of scrambling for low discrepancy numbers.

mcLoops, mcSteps

the number of Monte Carlo loops and Monte Carlo Steps. In total mcLoops*mcSteps samples are included in one MC simulation.

path.gen

the user defined function to generate the price path. As the only input argument serves the matrix of innovations, the option parameters must be available as global variables.

pathLength

the length of the price path. This may be calculated as floor(Time/delta.t), where Time denotes the time to maturation measured in years.

payoff.calc

a user defined function to calculate the payoff of the option. As the only input argument serves the path matrix as returned by the path generator. The option parameters must be available as global variables.

standardization

a logical flag, should the innovations for one loop be standardized? By default TRUE.

trace

a logical flag, should the Monte Carlo simulation be traced? By default TRUE.

…

additional arguments passed to the innovations generator.

Value

The user defined innovation generator returns a numeric matrix of (random) innovations to build the Monte Carlo Paths.

The user defined path generator returns a numeric matrix of the Monte Carlo paths for the calculation of the option's payoffs. To be more precise, as an example the function returns for a Wiener process the matrix (b-sigma*sigma/2)*delta.t + sigma*sqrt(delta.t)*innovations, where the first term corresponds to the drift and the second to the volatility.

The user defined payoff calculator, returns the vector of the option's payoffs calculated from the generated paths. As an example this becomes for an arithmetic Asian call option with a Wiener Monte Carlo path payoff = exp(-r*Time)*max(SM-X, 0) where SM = mean(S*exp(cumsum(path))) and path denotes the MC price paths.

MonteCarloOption: returns a vector with the option prices for each Monte Carlo loop.

Details

The Innovations:

The innovations must created by the user defined innovation generator. The Generator has to return a numeric matrix of (random) innovations of size mcSteps times the pathLength. The example section shows how to write sa function for scrambled Quasi Monte Carlo Sobol numbers. The package comes with three generators rnorm.pseudo, rnorm.halton and rnorm.sobol which can easily be used for simulations.

The Price Paths:

The user must provide a function which generates the price paths. In the example section the function wienerPath creates a Wiener Monte Carlo path from random innovations. The Wiener price path requires as input b, the annualized cost-of-carry rate, and sigma, the annualized volatility of the underlying security, to compute the drift and variance of the path, these variables must be globally defined.

The Payoff Function:

The user must also provide a function which computes the payoff value of the option. The example sections show how to write payoff calculators for the plain vanilla option and for the arithmetic Asian Option. As the only input argument the path matrix is required. Again, the option parameters must be globally available.

The Monte Carlo Simulator:

The simulator is the heart of the Monte Carlo valuation process. This simulator performs mcLoops Monte Carlo loops each with mcSteps Monte Carlo steps. In each loop the following steps are done: first the innovation matrix is created from the specified innovation generator (usually build from the normal pseudo random number or low discrepancy generators), then anththetic innovations are added if desired (by default anththetic=TRUE), then the innovations can be standardized within each loop (by default standardization=FALSE), and finally the average payoff of all samples in the loop is computed. The simulation can be traced loop by loop setting the argument trace=TRUE.

References

Birge J.R. (1994); Quasi-Monte Carlo Approaches to Option Pricing, Department of Industrial and Operations Engineering, Technical Report 94--19, University of Michigan.

Boyle P. (1977); Options: A Monte Carlo approach, Journal of Finance, 32, 323--338.

Glasserman P. (2004); Monte Carlo Methods in Financial Engineering, Springer-Verlag New York, Inc., 596 pp.

Jaeckel P. (2002); Monte Carlo Methods in Finance, John Wiley and Sons Ltd, 222 pp.

Examples

# NOT RUN {
## How to perform a Monte Carlo Simulation?
   
## First Step:
   # Write a function to generate the option's innovations. 
   # Use scrambled normal Sobol numbers:
   sobolInnovations <- function(mcSteps, pathLength, init, ...) {
        # Create and return Normal Sobol Innovations:
        rnorm.sobol(mcSteps, pathLength, init, ...)
   }
    
## Second Step: 
   # Write a function to generate the option's price paths.  
   # Use a Wiener path:
   wienerPath <- function(eps) { 
     # Note, the option parameters must be globally defined!
     # Generate and return the Paths:
     (b-sigma*sigma/2)*delta.t + sigma*sqrt(delta.t)*eps
   }
      
## Third Step: 
   # Write a function for the option's payoff
   
   # Example 1: use the payoff for a plain Vanilla Call or Put:
   plainVanillaPayoff <- function(path) { 
     # Note, the option parameters must be globally defined!
     # Compute the Call/Put Payoff Value:
     ST <- S*exp(sum(path))
     if (TypeFlag == "c") payoff <- exp(-r*Time)*max(ST-X, 0)
     if (TypeFlag == "p") payoff <- exp(-r*Time)*max(0, X-ST)
     # Return Value:
     payoff 
   }
   
   # Example 2: use the payoff for an arithmetic Asian Call or Put:
   arithmeticAsianPayoff <- function(path) { 
     # Note, the option parameters must be globally defined!
     # Compute the Call/Put Payoff Value:
     SM <- mean(S*exp(cumsum(path)))
     if (TypeFlag == "c") payoff <- exp(-r*Time)*max(SM-X, 0)
     if (TypeFlag == "p") payoff <- exp(-r*Time)*max(0, X-SM)
     # Return Value:
     payoff
   }

## Final Step: 
   # Set Global Parameters for the plain Vanilla / arithmetic Asian Options:
   TypeFlag <- "c"; S <- 100; X <- 100
   Time <- 1/12; sigma <- 0.4; r <- 0.10; b <- 0.1
   
   # Do the Asian Simulation with scrambled random numbers:
   mc <- MonteCarloOption(delta.t = 1/360, pathLength = 30, mcSteps = 5000, 
     mcLoops = 50, init = TRUE, innovations.gen = sobolInnovations, 
     path.gen = wienerPath, payoff.calc = arithmeticAsianPayoff, 
     antithetic = TRUE, standardization = FALSE, trace = TRUE, 
     scrambling = 2, seed = 4711)
   
   # Plot the MC Iteration Path:
   par(mfrow = c(1, 1))
   mcPrice <- cumsum(mc)/(1:length(mc))
   plot(mcPrice, type = "l", main = "Arithmetic Asian Option", 
        xlab = "Monte Carlo Loops", ylab = "Option Price")
    
   # Compare with Turnbull-Wakeman Approximation:
    if(FALSE) { #   ... requires(fExoticOptions)
      TW <- TurnbullWakemanAsianApproxOption(
                     TypeFlag = "c", S = 100, SA = 100, X = 100, 
                     Time = 1/12, time = 1/12, tau = 0 , r = 0.1,
                     b = 0.1, sigma = 0.4)$price
      print(TW)
    } else 
      TW <- 2.859122 

    abline(h = TW, col = 2)
# }