Asymptotic expansion of European options with mean-reverting stochastic volatility dynamics

Jun Hu and Juho Kanniainen

Finance Research Letters, 2015, vol. 14, issue C, 1-10

Abstract: We develop methods for pricing European options under general mean-reverting stochastic volatility dynamics, which can be used with both affine and non-affine volatility models. In our methods, the option price under stochastic volatility is expanded as a power series of parameters or variables by transferring the original partial differential equation to a set of solvable inhomogeneous Black–Scholes equations. The analytic approximation is more generally applicable than the fast Fourier transform, because it does not rely on the existence of a characteristic function. Finally, we numerically demonstrate our approach with the Heston, 3/2, and continuous-time GARCH models.

Keywords: Option pricing; Series expansion; PDE; Stochastic volatility; Non-affine models (search for similar items in EconPapers)
JEL-codes: C02 C32 C63 G13 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:14:y:2015:i:c:p:1-10

DOI: 10.1016/j.frl.2015.07.004

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