Investigating Time-Efficient Methods to Price Compound Options in the Heston Model
AbstractThe primary purpose of this paper is to provide an in-depth analysis of a number of structurally different methods to numerically evaluate European compound option prices under Heston’s stochastic volatility dynamics. Therefore, we first outline several approaches that can be used to price these type of options in the Heston model: a modified sparse grid method, a fractional fast Fourier transform technique, a (semi-)analytical valuation formula using the Green’s function of logarithmic spot and volatility and a Monte Carlo simulation. Then we compare the methods on a theoretical basis and report on their numerical properties with respect to computational times and accuracy. One key element of our analysis is that the analyzed methods are extended to incorporate piecewise time-dependent model parameters, which allows for a more realistic compound option pricing.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 328.
Date of creation: 01 Apr 2013
Date of revision:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-04-27 (All new papers)
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