Stochastic Volatility with an Ornstein-Uhlenbeck Process: An Extension
18 Pages Posted: 7 Sep 1998
Date Written: June 1998
In this paper, we reexamine and extend the stochastic volatility model of Stein and Stein (1991) where volatility follows a mean-reversion Ornstein-Uhlenbeck process. Using Fourier inversion techniques we are able to allow for correlation between instantaneous volatilities and the underlying stock returns. A closed-form pricing solution for European options is derived and some numerical examples are given.
JEL Classification: G13
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