Monte Carlo Simulation for Advanced Option Pricing: A Simplifying Tool

21 Pages Posted: 21 Apr 2005

See all articles by Jason Fink

Jason Fink

James Madison University - College of Business

Kristin Fink

James Madison University - College of Business

Date Written: March 2005

Abstract

Finance students at the undergraduate and MBA levels are increasingly in possession of significant mathematical skills, corresponding with the rise in cross-listings of courses between mathematics and finance departments. This increase in mathematical skill has opened the door for the Black Scholes model to be presented to advanced undergraduate and MBA students. However, although these students can grasp the weaknesses of the Black Scholes model, they are often not mathematically advanced enough to handle more realistic option pricing models. We demonstrate how Monte Carlo simulation may be employed to open the field of advanced option pricing to students without requiring any more mathematical knowledge than basic calculus and intermediate statistics. As an example, we demonstrate how to simulate option values when the underlying process follows Heston's stochastic volatility process, and motivate the example by demonstrating the significant improvement of a properly specified stochastic volatility model over the Black Scholes model.

Keywords: Simulation, teaching

JEL Classification: A20

Suggested Citation

Fink, Jason and Fink, Kristin, Monte Carlo Simulation for Advanced Option Pricing: A Simplifying Tool (March 2005). Available at SSRN: https://ssrn.com/abstract=704523 or http://dx.doi.org/10.2139/ssrn.704523

Jason Fink (Contact Author)

James Madison University - College of Business ( email )

Harrisonburg, VA 22807
United States
540-568-8107 (Phone)

Kristin Fink

James Madison University - College of Business ( email )

Harrisonburg, VA 22807
United States

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