Efficient Simulation of the Heston Stochastic Volatility Model
Leif B. G. Andersen
Bank of America Merrill Lynch
January 23, 2007
Stochastic volatility models are increasingly important in practical derivatives pricing applications, yet relatively little work has been undertaken in the development of practical Monte Carlo simulation methods for this class of models. This paper considers several new algorithms for time-discretization and Monte Carlo simulation of Heston-type stochastic volatility models. The algorithms are based on a careful analysis of the properties of affine stochastic volatility diffusions, and are straightforward and quick to implement and execute. Tests on realistic model parameterizations reveal that the computational efficiency and robustness of the simulation schemes proposed in the paper compare very favorably to existing methods.
Number of Pages in PDF File: 38
Keywords: Heston model, Monte Carlo simulation, SDE discretization, bias reduction, affine square-root models
JEL Classification: C63, G13working papers series
Date posted: November 22, 2006
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