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Paper #1188

A decomposition formula for option prices in the Heston model and applications to option pricing approximation
Elisa Al˛s
Desembre 2009
By means of classical It˘'s calculus we decompose option prices as the sum of the classical Black-Scholes formula with volatility parameter equal to the root-mean-square future average volatility plus a term due by correlation and a term due to the volatility of the volatility. This decomposition allows us to develop first and second-order approximation formulas for option prices and implied volatilities in the Heston volatility framework, as well as to study their accuracy. Numerical examples are given.
Paraules clau:
Stochastic Volatility, Heston Model, It˘'s Calculus.
Codis JEL:
Àrea de Recerca:
Estadística, Econometria i Mètodes Quantitatius

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