Pricing vulnerable options with stochastic volatility (Q2147889)

The authors investigate the pricing issue of vulnerable options with stochastic volatility by decomposing stochastic volatility into the long-term and short-term volatility. The short-term fluctuation of stochastic volatility is modeled by a mean-reverting process, and the long-term volatility is supposed to be a constant. Based on the proposed model, a pricing formula of vulnerable options is derived in a special case. Numerical results are presented to illustrate the impacts of two stochastic volatility components on vulnerable option prices.