FX Smile in the Heston Model

Agnieszka Janek, Tino Kluge, Rafał Weron and Uwe Wystup

MPRA Paper from University Library of Munich, Germany

Abstract: The Heston model stands out from the class of stochastic volatility (SV) models mainly for two reasons. Firstly, the process for the volatility is non-negative and mean-reverting, which is what we observe in the markets. Secondly, there exists a fast and easily implemented semi-analytical solution for European options. In this article we adapt the original work of Heston (1993) to a foreign exchange (FX) setting. We discuss the computational aspects of using the semi-analytical formulas, performing Monte Carlo simulations, checking the Feller condition, and option pricing with FFT. In an empirical study we show that the smile of vanilla options can be reproduced by suitably calibrating three out of five model parameters.

Keywords: Heston model; vanilla option; stochastic volatility; Monte Carlo simulation; Feller condition; option pricing with FFT (search for similar items in EconPapers)
JEL-codes: C5 C63 G13 (search for similar items in EconPapers)
Date: 2010-09
New Economics Papers: this item is included in nep-cmp and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/25491/1/MPRA_paper_25491.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/26357/1/MPRA_paper_26357.pdf revised version (application/pdf)

Related works:
Working Paper: FX Smile in the Heston Model (2010)
Working Paper: FX Smile in the Heston Model (2010)
Working Paper: FX smile in the Heston model (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:25491

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().