A fast Fourier transform technique for pricing American options under stochastic volatility

Zhylyevskyy, Oleksandr (Alex)

Staff General Research Papers from Iowa State University, Department of Economics

Abstract: This paper develops a non-finite-difference-based method of American option pricing under stochastic volatility by extending the Geske-Johnson compound option scheme. The characteristic function of the underlying state vector is inverted to obtain the vector’s density using a kernel-smoothed fast Fourier transform technique. The method produces option values that are closely in line with the values obtained by finite-difference schemes. It also performs well in an empirical application with traded S&P 100 index options. The method is especially well suited to price a set of options with different strikes on the same underlying asset, which is a task often encountered by practitioners.

Keywords: Stochastic; volatility; -; Heston; model; -; Geske-Johnson; scheme; -; Fast; Fourier; transform; -; Characteristic; function; inversion (search for similar items in EconPapers)
JEL-codes: G0 (search for similar items in EconPapers)
Date: 2009-09-18
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Published in Review of Derivatives Research, September 2009.

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Persistent link: http://EconPapers.repec.org/RePEc:isu:genres:13112

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