Paper #1188

Títol:

A decomposition formula for option prices in the Heston model and applications to option pricing approximation

Autor:

Elisa Alòs

Data:

Desembre 2009

Resum:

By means of classical Itô'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, Itô's Calculus.

Codis JEL:

G13

Àrea de Recerca:

Estadística, Econometria i Mètodes Quantitatius

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