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Pricing the European call option in the model with stochastic volatility driven by Ornstein--Uhlenbeck process. Exact formulas

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  • Sergii Kuchuk-Iatsenko
  • Yuliya Mishura

Abstract

We consider the Black--Scholes model of financial market modified to capture the stochastic nature of volatility observed at real financial markets. For volatility driven by the Ornstein--Uhlenbeck process, we establish the existence of equivalent martingale measure in the market model. The option is priced with respect to the minimal martingale measure for the case of uncorrelated processes of volatility and asset price, and an analytic expression for the price of European call option is derived. We use the inverse Fourier transform of a characteristic function and the Gaussian property of the Ornstein--Uhlenbeck process.

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  • Sergii Kuchuk-Iatsenko & Yuliya Mishura, 2015. "Pricing the European call option in the model with stochastic volatility driven by Ornstein--Uhlenbeck process. Exact formulas," Papers 1510.01848, arXiv.org.
    • Handle: RePEc:arx:papers:1510.01848
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    References listed on IDEAS

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    1. Stein, Elias M & Stein, Jeremy C, 1991. "Stock Price Distributions with Stochastic Volatility: An Analytic Approach," The Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 727-752.
    2. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. "Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-1632, December.
    3. Scott, Louis O., 1987. "Option Pricing when the Variance Changes Randomly: Theory, Estimation, and an Application," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(4), pages 419-438, December.
    4. Josep Perello & Ronnie Sircar & Jaume Masoliver, 2008. "Option pricing under stochastic volatility: the exponential Ornstein-Uhlenbeck model," Papers 0804.2589, arXiv.org, revised May 2008.
    5. Hull, John C & White, Alan D, 1987. "The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
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    Cited by:

    1. Sergii Kuchuk-Iatsenko & Yuliya Mishura, 2016. "Option pricing in the model with stochastic volatility driven by Ornstein--Uhlenbeck process. Simulation," Papers 1601.01128, arXiv.org.
    2. S. Kuchuk-Iatsenko & Y. Mishura & Y. Munchak, 2016. "Application of Malliavin calculus to exact and approximate option pricing under stochastic volatility," Papers 1608.00230, arXiv.org.
    3. Viktor Bezborodov & Luca Persio & Yuliya Mishura, 2019. "Option Pricing with Fractional Stochastic Volatility and Discontinuous Payoff Function of Polynomial Growth," Methodology and Computing in Applied Probability, Springer, vol. 21(1), pages 331-366, March.

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