A PARSIMONIOUS MULTI-ASSET HESTON MODEL: CALIBRATION AND DERIVATIVE PRICING

Georgi Dimitroff (), Stefan Lorenz () and Alexander Szimayer ()
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Georgi Dimitroff: DZ Bank AG, Platz der Republik, 60265 Frankfurt am Main, Germany
Stefan Lorenz: Fraunhofer ITWM, Fraunhofer-Platz 1, 67663 Kaiserslautern, Germany
Alexander Szimayer: Department of Business Administration, University of Hamburg, Von-Melle-Park 5, 20146 Hamburg, Germany

International Journal of Theoretical and Applied Finance (IJTAF), 2011, vol. 14, issue 08, 1299-1333

Abstract: We propose a parsimonious multi-asset Heston model and provide an easy-to-implement calibration algorithm. The model is customized to pricing multi-asset options in markets with liquidly traded single-asset options but no liquidly traded cross-asset options. In this situation, single-asset model parameters can be calibrated from option price data, however, cross-asset parameters cannot. We formulate a parsimonious model specification such that all single-asset models are Heston models, which are affine allowing for efficient calibration of the respective parameters. The single-asset models are correlated using cross-asset correlations only. Cross-asset correlations are observable, in contrast to correlations of latent variables such as volatilities, and serve as basis for calibration. A hybrid calibration approach for identifying the model parameters consistent with option price data and asset price data is outlined and illustrated by a case study. In banking practice the approach is referred to as correlation adjustment.

Keywords: Heston model; multi-asset; option pricing; calibration; correlation (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S021902491100653X

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