Monte Carlo Valuation of Compound Options on Conditional Securities

Summary

The document asks how to value a compound option when its underlying instrument is itself option-like and has additional conditions. A preferred share with conversion rights and dividends is given as an example. The author is considering Monte Carlo methods because the instrument’s terms may require modeling multiple contingent outcomes, and asks whether the Longstaff–Schwartz regression approach could be used.

The text provides no answer, valuation formula, numerical experiment, or references beyond mentioning prior work on compound options. It therefore serves mainly as a focused research question about extending simulation-based valuation to complex securities. Any application would need to specify the contractual conditions, exercise timing, state variables, and cash flows before the suitability of a regression-based method could be assessed.

Key ideas

• The instrument being valued may have an option as its underlying exposure.
• Preferred shares with conversion rights and dividends are offered as an example of a complex underlying security.
• Monte Carlo methods are considered because multiple contractual conditions may need explicit modeling.
• The author asks whether Longstaff–Schwartz regression can value such compound instruments.
• The document poses the valuation problem but supplies no method validation or empirical evidence.

Tags

# Compound Option Monte Carlo Methods Reference Request


# Compound Option Monte Carlo Methods Reference Request












I am interested in valuing option where the underlying security is similar (not exact) to an option. The underlying security might be a Preferred Share (option to convert into common share plus dividend). I am going over the paper Valuation of Compound options by Geske, however I want to inquire if anyone has some references for valuing such securities using Monte Carlo method.

The main reason I ask is because the underlying security (option) of the compound option for my case tend to have several conditions that requires me to model them using Monte Carlo Methods.

I am currently trying to figure out if I can apply the Longstaff Schwarz regression method to value such instruments. Any advice or references/papers would be very helpful. I am not interested in using call-put parity formulas to value such instruments, as they do not apply to my case. Thanks for the help.

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