Simulation schemes for the Heston model with Poisson conditioning

Jaehyuk Choi and Yue Kuen Kwok

Papers from arXiv.org

Abstract: Exact simulation schemes under the Heston stochastic volatility model (e.g., Broadie-Kaya and Glasserman-Kim) suffer from computationally expensive modified Bessel function evaluations. We propose a new exact simulation scheme without the modified Bessel function, based on the observation that the conditional integrated variance can be simplified when conditioned by the Poisson variate used for simulating the terminal variance. Our approach also enhances the low-bias and time discretization schemes, which are suitable for pricing derivatives with frequent monitoring. Extensive numerical tests reveal the good performance of the new simulation schemes in terms of accuracy, efficiency, and reliability when compared with existing methods.

Date: 2023-01, Revised 2023-11
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Published in European Journal of Operational Research, 314(1):363-376, 2024

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