Derivative Pricing with Multivariate Stochastic Volatility: Application to Credit Risk
Les Cahiers du CREF of HEC Montréal Working Paper No. CREF 04-09
49 Pages Posted: 18 Jul 2005
Date Written: May 2004
This paper extends to the multiasset framework the closed-form solution for options with stochastic volatility derived in Heston (1993) and Ball and Roma (1994). This extension introduces a risk premium in the return equation and considers Wishart dynamics for the process of the stochastic volatility matrix, which is the multiasset analogue of the model of Cox, Ingersoll, and Ross (1985). This approach is used to extend Merton's model for corporate default to a framework with stochastic liability.
Keywords: Stochastic volatility, derivative pricing, Wishart process, credit risk
JEL Classification: G12, G13
Suggested Citation: Suggested Citation