Leave-One-Out Least Square Monte Carlo Algorithm for Pricing American Options

Abstract

The least square Monte Carlo (LSM) algorithm proposed by Longstaff and Schwartz [2001] is widely used for pricing American options. The LSM estimator contains undesirable look-ahead bias, and the conventional technique of removing it necessitates doubling simulations. We present the leave-one-out LSM (LOOLSM) algorithm for efficiently eliminating lookahead bias. We validate the method with several option examples, including the multi-asset cases that the LSM algorithm significantly overvalues. We also obtain the convergence rates of look-ahead bias by measuring it using the LOOLSM method. The analysis and computational evidence support our findings.