On The Heston Model with Stochastic Interest Rates
AbstractWe discuss the Heston [Heston-1993] model with stochastic interest rates driven by Hull-White [Hull,White-1996] (HW) or Cox-Ingersoll-Ross [Cox, et al.-1985] (CIR) processes. A so-called volatility compensator is defined which guarantees that the Heston hybrid model with a non-zero correlation between the equity and interest rate processes is properly defined. Two different approximations of the hybrid models are presented in order to obtain the characteristic functions. These approximations admit pricing basic derivative products with Fourier techniques [Carr,Madan-1999; Fang,Oosterlee-2008], and can therefore be used for fast calibration of the hybrid model. The effect of the approximations on the instantaneous correlations and the influence of the correlation between stock and interest rate on the implied volatilities are also discussed.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 20620.
Date of creation: 17 Feb 2009
Date of revision: 18 Jan 2010
Heston-Hull-White; Heston-Cox-Ingersoll-Ross; equity-interest rate hybrid products; stochastic volatility; affine jump diffusion processes.;
Find related papers by JEL classification:
- G1 - Financial Economics - - General Financial Markets
- F3 - International Economics - - International Finance
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-02-27 (All new papers)
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