Weighted average price in the Heston stochastic volatility model

M. Papi (), L. Pontecorvi () and C. Donatucci
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M. Papi: Università Campus Biomedico
L. Pontecorvi: Università Campus Biomedico
C. Donatucci: Università Rome TRE

Decisions in Economics and Finance, 2017, vol. 40, issue 1, No 19, 373 pages

Abstract: Abstract We propose a weighted average formulation for the Heston stochastic volatility option price to avoid the estimation of the initial volatility. This approach has been developed in the literature for the estimation of the distribution of stock price changes (returns), showing an excellent agreement with real market data. We extend this method to the calibration of option prices considering a large class of probability distributions assumed for the initial volatility parameter. The estimation error is shown to be less than the case of the simple pricing formula. Our results are also validated with a numerical comparison on observed call prices, between the proposed calibration method and the classical approach.

Keywords: Option price; Stochastic volatility; Heston model; Calibration (search for similar items in EconPapers)
JEL-codes: C02 C22 C52 C61 G13 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1007/s10203-017-0197-5

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