Efficient Simulation of the Heston Stochastic Volatility Model

38 Pages Posted: 22 Nov 2006

Date Written: January 23, 2007

Abstract

Stochastic volatility models are increasingly important in practical derivatives pricing applications, yet relatively little work has been undertaken in the development of practical Monte Carlo simulation methods for this class of models. This paper considers several new algorithms for time-discretization and Monte Carlo simulation of Heston-type stochastic volatility models. The algorithms are based on a careful analysis of the properties of affine stochastic volatility diffusions, and are straightforward and quick to implement and execute. Tests on realistic model parameterizations reveal that the computational efficiency and robustness of the simulation schemes proposed in the paper compare very favorably to existing methods.

Keywords: Heston model, Monte Carlo simulation, SDE discretization, bias reduction, affine square-root models

JEL Classification: C63, G13

Suggested Citation

Andersen, Leif B.G., Efficient Simulation of the Heston Stochastic Volatility Model (January 23, 2007). Available at SSRN: https://ssrn.com/abstract=946405 or http://dx.doi.org/10.2139/ssrn.946405

Leif B.G. Andersen (Contact Author)

Bank of America Merrill Lynch ( email )

One Bryant Park
New York, NY 10036
United States
646-855-1835 (Phone)

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