A Note on the Discontinuity Problem in Heston's Stochastic Volatility Model

Jia-Hau Guo and Mao-Wei Hung

Applied Mathematical Finance, 2007, vol. 14, issue 4, 339-345

Abstract: Although quasi-analytic formulas can be derived for European-style financial claims in Heston's stochastic volatility model, the inverse Fourier integration involved makes the calculation somewhat complicated. This challenge has puzzled practitioners for many years because most implementations of Heston's formula are not robust, even for customarily-used Heston parameters, as time to maturity is increased. In this article, a simplified approach is proposed to solve the numerical instability problem inherent to the fundamental solution of the Heston model. Specifically, the solution does not require any additional function or a particular mechanism for most software packages or programming library routines to correctly evaluate Heston's analytics.

Keywords: Stochastic volatility model; Heston; discountinuity; options (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (3)

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DOI: 10.1080/13504860601170534

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