Decomposition formula for jump diffusion models
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Abstract: In this paper we derive a generic decomposition of the option pricing formula for models with finite activity jumps in the underlying asset price process (SVJ models). This is an extension of the well-known result by Alos (2012) for Heston (1993) SV model. Moreover, explicit approximation formulas for option prices are introduced for a popular class of SVJ models - models utilizing a variance process postulated by Heston (1993). In particular, we inspect in detail the approximation formula for the Bates (1996) model with log-normal jump sizes and we provide a numerical comparison with the industry standard - Fourier transform pricing methodology. For this model, we also reformulate the approximation formula in terms of implied volatilities. The main advantages of the introduced pricing approximations are twofold. Firstly, we are able to significantly improve computation efficiency (while preserving reasonable approximation errors) and secondly, the formula can provide an intuition on the volatility smile behaviour under a specific SVJ model.
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Cited in
(7)- A decomposition formula for option prices in the Heston model and applications to option pricing approximation
- Decomposition formula for rough Volterra stochastic volatility models
- Approximate option pricing formula for Barndorff-Nielsen and Shephard model
- Approximate option pricing under a two-factor Heston-Kou stochastic volatility model
- Alòs type decomposition formula for Barndorff-Nielsen and Shephard model
- Decomposition of the option pricing formula for infinite activity jump-diffusion stochastic volatility models
- Removing the jump-Kato's decomposition
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