Series Expansion and Fourth-Order Global Padé Approximation for a Rough Heston Solution

Siow Woon Jeng and Adem Kilicman
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Siow Woon Jeng: Department of Mathematics and Institute for Mathematical Research, University Putra Malaysia, Serdang 43400, Selangor, Malaysia
Adem Kilicman: Department of Mathematics and Institute for Mathematical Research, University Putra Malaysia, Serdang 43400, Selangor, Malaysia

Mathematics, 2020, vol. 8, issue 11, 1-26

Abstract: The rough Heston model has recently been shown to be extremely consistent with the observed empirical data in the financial market. However, the shortcoming of the model is that the conventional numerical method to compute option prices under it requires great computational effort due to the presence of the fractional Riccati equation in its characteristic function. In this study, we contribute by providing an efficient method while still retaining the quality of the solution under varying Hurst parameter for the fractional Riccati equations in two ways. First, we show that under the Laplace–Adomian-decomposition method, the infinite series expansion of the fractional Riccati equation’s solution corresponds to the existing expansion method from previous work for at least up to the fifth order. Then, we show that the fourth-order Padé approximants can be used to construct an extremely accurate global approximation to the fractional Riccati equation in an unexpected way. The pointwise approximation error of the global Padé approximation to the fractional Riccati equation is also provided. Unlike the existing work of third-order global Padé approximation to the fractional Riccati equation, our work extends the availability of Hurst parameter range without incurring huge errors. Finally, numerical comparisons were conducted to verify that our methods are indeed accurate and better than the existing method for computing both the fractional Riccati equation’s solution and option prices under the rough Heston model.

Keywords: rough Heston model; fractional Riccati equation; Laplace Adomian decomposition method; fourth-order global padé approximation (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2020
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