Discrete Cash Dividends and American Option Approximation Risks

Summary

The document asks which analytic approximation is most accurate for American options with discrete cash dividends and what can go wrong when discrete payments are represented by a continuous dividend yield. The supplied response names a commercial pricing base but gives no comparison, derivation, or evidence supporting its selection as the leading approximation.

It identifies a central modeling difference: discrete dividends create a price break on ex-dividend dates, while a continuous yield smooths that effect over time. The response says this substitution can affect call valuation and produce mismatched Greeks, with discrepancies depending on the dividend schedule. It offers no quantitative estimates or detailed treatment of exercise behavior, so these points are qualitative cautions rather than a complete model assessment.

Key ideas

• Discrete cash dividends can create price jumps at ex-dividend dates that a continuous yield smooths away.
• Replacing discrete dividends with a continuous yield can alter American option prices and Greeks.
• The size of the discrepancy may depend on the dividend schedule.
• The document does not compare analytic approximations or provide quantitative evidence for its brief recommendation.

Tags

# most accurate analytic approximation for American options with cash dividends


# most accurate analytic approximation for American options with cash dividends












I have a two-part question regarding American option pricing:

- Which analytic approximation is currently considered the most accurate for valuing American options with discrete cash dividends?

- In the absence of a dedicated discrete model, what are the primary pricing discrepancies and risks associated with substituting discrete dividends with a continuous dividend yield?

## Answer by João (score 0)

https://quant.stackexchange.com/a/85307

- Voladynamics base

- you'll miss the "break" of the GBM, misprice has there's no jump ex-date time just a smooth continuous yield, undervalue calls, mismatched greeks and depending on the dividends schedules e.g., FTSE, SPX, NIKKEI there will be wider gaps

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.