A Simple Approach to Pricing American Options Under the Heston Stochastic Volatility Model

Abstract:     
In a recent paper, Beliaeva and Nawalkha [2008] present a multidimensional transform for generating path-independent trees for pricing American options under low-dimensional stochastic volatility models. This approach has advantages over both the GARCH tree method of Ritchken and Trevor [1999] and the Monte Carlo regression method of Longstaff and Schwartz [2001]. In this paper, we give an explicit demonstration of this approach using the specific example of the Heston [1993] stochastic volatility model. This approach obtains highly accurate American option prices within a fraction of a second using the control variate method.

Keywords: Heston, options, stochastic volatility, American options, trees

JEL Classifications: G0, G11, G12, G13, G20, G21, G22, G23, G24

Working Paper Series