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Strong convergence rates for Euler approximations to a class of stochastic path-dependent volatility models

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  • Andrei Cozma
  • Christoph Reisinger

Abstract

We consider a class of stochastic path-dependent volatility models where the stochastic volatility, whose square follows the Cox-Ingersoll-Ross model, is multiplied by a (leverage) function of the spot price, its running maximum, and time. We propose a Monte Carlo simulation scheme which combines a log-Euler scheme for the spot process with the full truncation Euler scheme or the backward Euler-Maruyama scheme for the squared stochastic volatility component. Under some mild regularity assumptions and a condition on the Feller ratio, we establish the strong convergence with order 1/2 (up to a logarithmic factor) of the approximation process up to a critical time. The model studied in this paper contains as special cases Heston-type stochastic-local volatility models, the state-of-the-art in derivative pricing, and a relatively new class of path-dependent volatility models. The present paper is the first to prove the convergence of the popular Euler schemes with a positive rate, which is moreover consistent with that for Lipschitz coefficients and hence optimal.

Suggested Citation

  • Andrei Cozma & Christoph Reisinger, 2017. "Strong convergence rates for Euler approximations to a class of stochastic path-dependent volatility models," Papers 1706.07375, arXiv.org, revised Oct 2018.
    • Handle: RePEc:arx:papers:1706.07375
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    References listed on IDEAS

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