The Evaluation of American Compound Option Prices Under Stochastic Volatility Using the Sparse Grid Approach
A compound option (the mother option) gives the holder the right, but not obligation to buy (long) or sell (short) the underlying option (the daughter option). In this paper, we demonstrate a partial differential equation (PDE) approach to pricing American-type compound options where the underlying dynamics follow Heston’s stochastic volatility model. This price is formulated as the solution to a two-pass free boundary PDE problem. A modified sparse grid approach is implemented to solve the PDEs, which is shown to be accurate and efficient compared with the results from Monte Carlo simulation combined with the Method of Lines.
|Date of creation:||01 Feb 2009|
|Publication status:||Published as: Chiarella, C. and Kang, B., 2013, "The Evaluation of American Compound Option Prices Under Stochastic Volatility and Stochastic Interest Rates", Journal of Computational Finance, 11(1), 71-92.|
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- Carl Chiarella & Boda Kang & Gunter H. Meyer & Andrew Ziogas, 2009.
"The Evaluation Of American Option Prices Under Stochastic Volatility And Jump-Diffusion Dynamics Using The Method Of Lines,"
International Journal of Theoretical and Applied Finance (IJTAF),
World Scientific Publishing Co. Pte. Ltd., vol. 12(03), pages 393-425.
- Carl Chiarella & Boda Kang & Gunter H. Meyer & Andrew Ziogas, 2008. "The Evaluation of American Option Prices Under Stochastic Volatility and Jump-Diffusion Dynamics Using the Method of Lines," Research Paper Series 219, Quantitative Finance Research Centre, University of Technology, Sydney.
- Thomas Adolfsson & Carl Chiarella & Andrew Ziogas & Jonathan Ziveyi, 2013. "Representation and Numerical Approximation of American Option Prices under Heston Stochastic Volatility Dynamics," Research Paper Series 327, Quantitative Finance Research Centre, University of Technology, Sydney.
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- Brenner, Menachem & Ou, Ernest Y. & Zhang, Jin E., 2006. "Hedging volatility risk," Journal of Banking & Finance, Elsevier, vol. 30(3), pages 811-821, March.
- Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, vol. 39(5), pages 1511-1524, December. Full references (including those not matched with items on IDEAS)
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