Asymptotic Expansion Formula of Option Price Under Multifactor Heston Model

Kazuki Nagashima (), Tsz-Kin Chung () and Keiichi Tanaka ()

Asia-Pacific Financial Markets, 2014, vol. 21, issue 4, 396 pages

Abstract: The stochastic volatility model of Heston (Rev Financ Stud 6(2):327–343, 1993 ) has found difficulty in describing some of the important features of implied volatility dynamics, leading to a quest for multifactor extensions as well as the incorporation of time-dependent model parameters. In this paper, an asymptotic expansion approach to the multifactor Heston model with time-dependent parameters is developed. The results of Benhamou et al. (SIAM J Financ Math 1(1):289–325, 2010 ) are extended and it is shown that the extension to the multifactor model involves an extra expansion term that captures the interaction between variance factors. The expansion formula under constant parameters can be explicitly computed and the incorporation of time-dependent parameters is straightforward under the framework. As illustration, a two-factor model is calibrated to data of index options and variance swaps and it is found that it is possible to distinguish a short-term and long-term variance factor from the implied volatility surface and variance swap rates. Moreover, the two-factor model is able to reproduce the shapes of the implied volatility surface during various market scenarios. Copyright Springer Japan 2014

Keywords: Asymptotic expansion; Malliavin calculus; Multifactor Heston model; Option pricing; Stochastic volatility; Variance swap (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://hdl.handle.net/10.1007/s10690-014-9189-4 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:kap:apfinm:v:21:y:2014:i:4:p:351-396

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10690/PS2

DOI: 10.1007/s10690-014-9189-4

Access Statistics for this article

Asia-Pacific Financial Markets is currently edited by Jiro Akahori

More articles in Asia-Pacific Financial Markets from Springer, Japanese Association of Financial Economics and Engineering
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().