On The Heston Model with Stochastic Interest Rates
We 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.
|Date of creation:||17 Feb 2009|
|Date of revision:||18 Jan 2010|
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- Fang, Fang & Oosterlee, Kees, 2008.
"A Novel Pricing Method For European Options Based On Fourier-Cosine Series Expansions,"
9319, University Library of Munich, Germany.
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