Interacting Particle System and its Application in Pricing Bermudan Options

Abstract

Interacting particle system (IPS) method has gained popularity in these days. The close relationship with importance sampling method and standard Monte Carlo methods contributes to a broad applications of IPS in derivative pricing and risk management. In this paper, we will introduce some basic ideas and theories behind IPS, and show its link to change of measure. We illustrate IPS with a simple random walk example, and show its application in pricing Bermudan options and compare IPS with other usually used methods, such as Binomial Tree and Longsta-Schwartz method.