Pricing American Options under Stochastic Volatility
This paper provides an extension of McKeanâ€™s (1965) incomplete Fourier transform method to solve the two-factor partial differential equation for the price and early exercise surface of an American call option, in the case where the volatility of the underlying evolves randomly. The Heston (1993) square-root process is used for the volatility dynamics. The price is given by an integral equation dependent upon the early exercise surface, using a free boundary approximation that is linear in volatility. By evaluating the pricing equation along the free surface boundary, we provide a corresponding integral equation for the early exercise region. An algorithm is proposed for solving the integral equation system, based upon numerical integration techniques for Volterra integral equations. The method is implemented, and the resulting prices are compared with the constant volatility model. The computational efficiency of the numerical integration scheme is also considered
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
When requesting a correction, please mention this item's handle: RePEc:sce:scecf5:77. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.