A Remark on a Singular Perturbation Method for Option Pricing Under a Stochastic Volatility Model

Posted: 18 Jun 2009 Last revised: 10 Nov 2009

See all articles by Kyo Yamamoto

Kyo Yamamoto

GCI Asset Management, Inc.

Akihiko Takahashi

University of Tokyo - Faculty of Economics

Date Written: July 8, 2009

Abstract

This paper studies the approximation accuracy of a singular perturbation method for option pricing up to the second order under a stochastic volatility model. First, numerical experiments confirm that the first order approximation provides sufficiently accurate option prices in a fast mean-reversion volatility case. On the other hand, it creates relatively large errors in a non-fast mean-reversion volatility environment. Then, the second order approximation formula is derived and the improvement of the approximation is investigated.

Keywords: option pricing, stochastic volatility, partial differential equation, singular perturbation, approximation accuracy

Suggested Citation

Yamamoto, Kyo and Takahashi, Akihiko, A Remark on a Singular Perturbation Method for Option Pricing Under a Stochastic Volatility Model (July 8, 2009). Asia-Pacific Financial Markets, Vol. 16, No. 4, pp. 333-345, 2009, Available at SSRN: https://ssrn.com/abstract=1421951

Kyo Yamamoto

GCI Asset Management, Inc. ( email )

12F Chiyoda First Bldg. East
3-8-1 Nishi-Kanda
Chiyoda-ku, Tokyo 101-0065
Japan

Akihiko Takahashi (Contact Author)

University of Tokyo - Faculty of Economics ( email )

7-3-1 Hongo, Bunkyo-ku
Tokyo 113-0033
Japan

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
654
PlumX Metrics