A General Decomposition Formula for Derivative Prices in Stochastic Volatility Models

UPF Economics and Business Working Paper No. 665

13 Pages Posted: 17 Oct 2003

See all articles by Elisa Alos

Elisa Alos

University of Pompeu Fabra - Department of Economics

Date Written: 2003

Abstract

We see that the price of a European call option in a stochastic volatility framework can be decomposed in the sum of four terms, which identify the main features of the market that affect option prices: the expected future volatility, the correlation between the volatility and the noise driving the stock prices, the market price of volatility risk and the difference of the expected future volatility at different times. We also study some applications of this decomposition.

Keywords: Continuous-time option pricing model, stochastic volatility, Ito's formula, incomplete markets.

JEL Classification: G130

Suggested Citation

Alos, Elisa, A General Decomposition Formula for Derivative Prices in Stochastic Volatility Models (2003). UPF Economics and Business Working Paper No. 665. Available at SSRN: https://ssrn.com/abstract=428081 or http://dx.doi.org/10.2139/ssrn.428081

Elisa Alos (Contact Author)

University of Pompeu Fabra - Department of Economics ( email )

c/o Ramon Trias Fargas 25-27
08005 Barcelona
Spain
34 93 542 19 25 (Phone)
34 93 542 17 46 (Fax)

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