Economics at your fingertips  

Exact simulation of the Ornstein–Uhlenbeck driven stochastic volatility model

Chenxu Li and Linjia Wu

European Journal of Operational Research, 2019, vol. 275, issue 2, 768-779

Abstract: This paper proposes a novel exact simulation method for the Ornstein–Uhlenbeck driven stochastic volatility model. To accomplish this goal, our task hinges on properly handling the Ornstein–Uhlenbeck volatility process. The major challenge involves conditionally sampling the integral of its square with respect to time given its marginal state as well as its integral with respect to time. We thus derive a closed-form Laplace transform of this conditional distribution via the techniques of changing probability measure as well as analytical extension. Then, we obtain the corresponding conditional cumulative distribution function via Fourier transform inversion and finally sample the distribution via the inverse transform method. We show that our method achieves a faster convergence rate of root-mean-square errors comparing with Euler discretization method, and apply it in the valuation of discretely monitored path-dependent options.

Keywords: Simulation; Stochastic volatility; Ornstein–Uhlenbeck process; Laplace transform; Analytical extension (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
Full text for ScienceDirect subscribers only

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:

Access Statistics for this article

European Journal of Operational Research is currently edited by Roman Slowinski, Jesus Artalejo, Jean-Charles. Billaut, Robert Dyson and Lorenzo Peccati

More articles in European Journal of Operational Research from Elsevier
Bibliographic data for series maintained by Dana Niculescu ().

Page updated 2019-03-16
Handle: RePEc:eee:ejores:v:275:y:2019:i:2:p:768-779