Journal
INTERNATIONAL JOURNAL OF THEORETICAL AND APPLIED FINANCE
Volume 13, Issue 7, Pages 1047-1063Publisher
WORLD SCIENTIFIC PUBL CO PTE LTD
DOI: 10.1142/S0219024910006108
Keywords
Econophysics; stochastic volatility; Monte Carlo simulation; option pricing; model calibration
Categories
Ask authors/readers for more resources
We consider the problem of option pricing under stochastic volatility models, focusing on the linear approximation of the two processes known as exponential Ornstein-Uhlenbeck and Stein-Stein. Indeed, we show they admit the same limit dynamics in the regime of low fluctuations of the volatility process, under which we derive the exact expression of the characteristic function associated to the risk neutral probability density. This expression allows us to compute option prices exploiting a formula derived by Lewis and Lipton. We analyze in detail the case of Plain Vanilla calls, being liquid instruments for which reliable implied volatility surfaces are available. We also compute the analytical expressions of the first four cumulants, that are crucial to implement a simple two steps calibration procedure. It has been tested against a data set of options traded on the Milan Stock Exchange. The data analysis that we present reveals a good fit with the market implied surfaces and corroborates the accuracy of the linear approximation.
Authors
I am an author on this paper
Click your name to claim this paper and add it to your profile.
Reviews
Recommended
No Data Available