Analytically Pricing European Options under a New Two-Factor Heston Model with Regime Switching

Sha Lin and Xin-Jiang He ()
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Sha Lin: Zhejiang Gongshang University
Xin-Jiang He: Zhejiang University of Technology

Computational Economics, 2022, vol. 59, issue 3, No 6, 1069-1085

Abstract: Abstract In this paper, we propose a new two-factor stochastic volatility model by introducing a regime switching factor into the Heston model. Despite the complicated model structure, we still manage to derive a closed-form pricing formula for European options, which can save us a lot of time in option pricing and model calibration. The results of our empirical study further indicate that our model is able to provide better performance over existing ones when real market data is employed, demonstrating its possible practical applications.

Keywords: Stochastic volatility; Two-factor; Regime switching; Closed-form; Empirical study (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s10614-021-10117-6

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