A Remark on a Singular Perturbation Method for Option Pricing under a Stochastic Volatility

Kyo Yamamoto and Akihiko Takahashi
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Kyo Yamamoto: Graduate School of Economics, University of Tokyo
Akihiko Takahashi: Faculty of Economics, University of Tokyo

No CIRJE-F-597, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: This paper studies the accuracy of a singular perturbation method for option pricing under a stochastic volatility model ([8]). First, through numerical experiments we confirm that the first order approximation provides sufficiently accurate option prices in a fast mean-reversion case of the volatility process while it does not in a non-fast mean-reversion case. Then, we derive the second order approximation formula and examine the improvement of the approximation.

Pages: 14pages
Date: 2008-10
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:tky:fseres:2008cf597

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