Investigating Time-Efficient Methods to Price Compound Options in the Heston Model

29 Pages Posted: 26 Feb 2013

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Susanne Griebsch

University of Technology, Sydney; Financial Research Network (FIRN)

Boda Kang

AMP

Date Written: February 25, 2013

Abstract

The primary purpose of this paper is to provide an in-depth analysis of a number of structurally different methods to numerically evaluate European compound option prices under Heston’s stochastic volatility dynamics. Therefore, we first outline several approaches that can be used to price these type of options in the Heston model: a modified sparse grid method, a fractional fast Fourier transform technique, a (semi-)analytical valuation formula using the Green’s function of logarithmic spot and volatility and a Monte Carlo simulation. Then we compare the methods on a theoretical basis and report on their numerical properties with respect to computational times and accuracy. One key element of our analysis is that the analyzed methods are extended to incorporate piecewise time-dependent model parameters, which allows for a more realistic compound option pricing.

Suggested Citation

Chiarella, Carl and Griebsch, Susanne and Kang, Boda, Investigating Time-Efficient Methods to Price Compound Options in the Heston Model (February 25, 2013). Available at SSRN: https://ssrn.com/abstract=2224387 or http://dx.doi.org/10.2139/ssrn.2224387

Carl Chiarella (Contact Author)

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Susanne Griebsch

University of Technology, Sydney ( email )

Haymarket, Ultimo
PO Box 123
Sydney, NSW 2007
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Boda Kang

AMP ( email )

Sydney, NSW
Australia
0430976988 (Phone)
2154 (Fax)

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