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A Low-Bias Simulation Scheme For The Sabr Stochastic Volatility Model

Listed author(s):


    (CWI, Center for Mathematics and Computer Science, Amsterdam, The Netherlands; Derivative Research & Validation, Rabobank International, Utrecht, The Netherlands)


    (CWI, Center for Mathematics and Computer Science, Amsterdam, The Netherlands)


    (Faculty of Electrical Engineering, Mathematics and Computer Science, TU Delft, The Netherlands)

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    The Stochastic Alpha Beta Rho Stochastic Volatility (SABR-SV) model is widely used in the financial industry for the pricing of fixed income instruments. In this paper we develop a low-bias simulation scheme for the SABR-SV model, which deals efficiently with (undesired) possible negative values in the asset price process, the martingale property of the discrete scheme and the discretization bias of commonly used Euler discretization schemes. The proposed algorithm is based the analytic properties of the governing distribution. Experiments with realistic model parameters show that this scheme is robust for interest rate valuation.

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    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 15 (2012)
    Issue (Month): 02 ()
    Pages: 1-37

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    Handle: RePEc:wsi:ijtafx:v:15:y:2012:i:02:p:1250016-1-1250016-37
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