Pricing of vulnerable options under hybrid stochastic and local volatility

Donghyun Kim, Sun-Yong Choi and Ji-Hun Yoon

Chaos, Solitons & Fractals, 2021, vol. 146, issue C

Abstract: In this study, considering the paradoxical stochastic characteristics of over-the-counter markets during a financial crisis, we examine the price of vulnerable options under the constant-elasticity-of-variance-with-stochastic-volatility (SVCEV) model. This model describes the market situation better than the stochastic volatility model as well as the constant-elasticity-of-variance model. We provide the corrected option price derived by asymptotic analysis, which is an approximation to the price of a vulnerable option under the SVCEV model. Furthermore, we numerically verify the accuracy of the price of a vulnerable option (as obtained using the SVCEV model) by comparing the approximate option price with the option price obtained by Monte Carlo simulation.

Keywords: Hybrid stochastic and local volatility; Vulnerable option; Asymptotic analysis; Monte-Carlo simulation (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:chsofr:v:146:y:2021:i:c:s0960077921001995

DOI: 10.1016/j.chaos.2021.110846

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