Efficient Pricing of European-Style Options Under Heston's Stochastic Volatility Model
AbstractHeston's stochastic volatility model is frequently employed by finance researchers and practitioners. Fast pricing of European-style options in this setting has considerable practical significance. This paper derives a computationally efficient formula for the value of a European-style put under Heston's dynamics, by utilizing a transform approach based on inverting the characteristic function of the underlying stock's log-price and by exploiting the characteristic function's symmetry. The value of a European-style call is computed using a parity relationship. The required characteristic function is obtained as a special case of a more general solution derived in prior research. Computational advantage of the option value formula is illustrated numerically. The method can help to mitigate the time cost of algorithms that require repeated evaluation of European-style options under Heston's dynamics.
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Bibliographic InfoPaper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 34827.
Date of creation: 23 Feb 2012
Date of revision:
Publication status: Published in Theoretical Economics Letters, February 2012, vol. 2 no. 1, pp. 16-20
Contact details of provider:
Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
Web page: http://www.econ.iastate.edu
More information through EDIRC
characteristic function inversion; Heston's model; European-style option;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-03-28 (All new papers)
- NEP-CMP-2012-03-28 (Computational Economics)
- NEP-FMK-2012-03-28 (Financial Markets)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Darrell Duffie & Jun Pan & Kenneth Singleton, 2000.
"Transform Analysis and Asset Pricing for Affine Jump-Diffusions,"
Econometric Society, vol. 68(6), pages 1343-1376, November.
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- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, vol. 39(5), pages 1511-24, December.
- Oleksandr Zhylyevskyy, 2010. "A fast Fourier transform technique for pricing American options under stochastic volatility," Review of Derivatives Research, Springer, vol. 13(1), pages 1-24, April.
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