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Weighted average price in the Heston stochastic volatility model

Author

Listed:
  • M. Papi

    (Università Campus Biomedico)

  • L. Pontecorvi

    (Università Campus Biomedico)

  • C. Donatucci

    (Università Rome TRE)

Abstract

We propose a weighted average formulation for the Heston stochastic volatility option price to avoid the estimation of the initial volatility. This approach has been developed in the literature for the estimation of the distribution of stock price changes (returns), showing an excellent agreement with real market data. We extend this method to the calibration of option prices considering a large class of probability distributions assumed for the initial volatility parameter. The estimation error is shown to be less than the case of the simple pricing formula. Our results are also validated with a numerical comparison on observed call prices, between the proposed calibration method and the classical approach.

Suggested Citation

  • M. Papi & L. Pontecorvi & C. Donatucci, 2017. "Weighted average price in the Heston stochastic volatility model," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 40(1), pages 351-373, November.
    • Handle: RePEc:spr:decfin:v:40:y:2017:i:1:d:10.1007_s10203-017-0197-5
    DOI: 10.1007/s10203-017-0197-5
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    References listed on IDEAS

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    1. Fouque,Jean-Pierre & Papanicolaou,George & Sircar,Ronnie & Sølna,Knut, 2011. "Multiscale Stochastic Volatility for Equity, Interest Rate, and Credit Derivatives," Cambridge Books, Cambridge University Press, number 9780521843584.
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    More about this item

    Keywords

    Option price; Stochastic volatility; Heston model; Calibration;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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