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Simulation schemes for the Heston model with Poisson conditioning

Author

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  • Choi, Jaehyuk
  • Kwok, Yue Kuen

Abstract

Exact simulation schemes under the Heston stochastic volatility model (e.g., Broadie–Kaya and Glasserman–Kim) suffer from computationally expensive modified Bessel function evaluations. We propose a new exact simulation scheme without the modified Bessel function, based on the observation that the conditional integrated variance can be simplified when conditioned by the Poisson variate used for simulating the terminal variance. Our approach also enhances the low-bias and time discretization schemes, which are suitable for pricing derivatives with frequent monitoring. Extensive numerical tests reveal the good performance of the new simulation schemes in terms of accuracy, efficiency, and reliability when compared with existing methods.

Suggested Citation

  • Choi, Jaehyuk & Kwok, Yue Kuen, 2024. "Simulation schemes for the Heston model with Poisson conditioning," European Journal of Operational Research, Elsevier, vol. 314(1), pages 363-376.
    • Handle: RePEc:eee:ejores:v:314:y:2024:i:1:p:363-376
    DOI: 10.1016/j.ejor.2023.10.048
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    File URL: http://www.sciencedirect.com/science/article/pii/S0377221723008238
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    Cited by:

    1. Jaehyuk Choi, 2024. "Exact simulation scheme for the Ornstein-Uhlenbeck driven stochastic volatility model with the Karhunen-Lo\`eve expansions," Papers 2402.09243, arXiv.org.

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