In the Longstaff & Schawartz article they condition on using In-The-Money (ITM) paths only for the regression. The reason for this is to obtain more accurate results and also reduce the computational burden. However, if I blindly implement this approach and the consider an American Put option that is far Out-of-The-Money (OTM) then it may very well happen that all of the paths are OTM and thus not part of the regression af they fail to satisfy the ITM-condition.

What are some goods methods to handle (far) OTM options using LSMC?

I could check if a certain percentage or number of paths are ITM before apply the condition but perhaps someone here can share some insight as of how to handle these details in practice.



Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.