Option Pricing with Orthogonal Polynomial Expansions

Abstract

We derive analytic series representations for European option prices in polynomial stochastic volatility models. This includes the Jacobi, Heston, Stein-Stein, and Hull-White models, for which we provide numerical case studies. We find that our polynomial option price series expansion performs as efficiently and accurately as the Fourier transform based method in the nested affine case. We also derive and numerically validate series representations for option Greeks. We depict an extension of our approach to exotic options whose payoffs depend on a finite number of prices.

Keywords: Greeks, Option Pricing, Orthogonal Polynomials, Parameter Sensitivity, Polynomial Diffusion Models, Stochastic Volatility

JEL Classification: C32, G12, G13