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Adaptive Simulation of the Heston Model

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  • Ian Iscoe
  • Asif Lakhany
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    Abstract

    Recent years have seen an increased level of interest in pricing equity options under a stochastic volatility model such as the Heston model. Often, simulating a Heston model is difficult, as a standard finite difference scheme may lead to significant bias in the simulation result. Reducing the bias to an acceptable level is not only challenging but computationally demanding. In this paper we address this issue by providing an alternative simulation strategy -- one that systematically decreases the bias in the simulation. Additionally, our methodology is adaptive and achieves the reduction in bias with "near" minimum computational effort. We illustrate this feature with a numerical example.

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    File URL: http://arxiv.org/pdf/1111.6067
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    Paper provided by arXiv.org in its series Papers with number 1111.6067.

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    Date of creation: Nov 2011
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    Handle: RePEc:arx:papers:1111.6067

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    1. Hormann, W., 1993. "The transformed rejection method for generating Poisson random variables," Insurance: Mathematics and Economics, Elsevier, vol. 12(1), pages 39-45, February.
    2. Lin Yuan & John Kalbfleisch, 2000. "On the Bessel Distribution and Related Problems," Annals of the Institute of Statistical Mathematics, Springer, vol. 52(3), pages 438-447, September.
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