Quadratic approximation of the slow factor of volatility in a multifactor stochastic volatility model

Gifty Malhotra, R. Srivastava and H. C. Taneja

Journal of Futures Markets, 2018, vol. 38, issue 5, 607-624

Abstract: A new multifactor stochastic volatility model is proposed in which the slow volatility factor is approximated by a quadratic arc. The perturbation technique is used to obtain the approximate expression for the European option price. The notion of a modified Black‐Scholes price is introduced. A simplified expression for the European option price, perturbed around the modified Black‐Scholes price, is obtained. An expression of modified price is also obtained in terms of the Black‐Scholes price. The effect of this modification on pricing is explained, the accuracy of the approximate option pricing formula established, and its computational cost discussed.

Date: 2018
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