Option pricing under Ornstein-Uhlenbeck stochastic volatility: a linear model

DOI10.1142/S0219024910006108MaRDI QIDQ3067763zbMATH OpenFDO

Authors V. Cazzola, Giacomo Bormetti, Danilo Delpini

Publication date 13 January 2011

Published in International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0905.1882

zbMATH Keywords

econophysicsmodel calibrationMonte Carlo simulationoption pricingstochastic volatility

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: We consider the problem of option pricing under stochastic volatility models, focusing on the linear approximation of the two processes known as exponential Ornstein-Uhlenbeck and Stein-Stein. Indeed, we show they admit the same limit dynamics in the regime of low fluctuations of the volatility process, under which we derive the exact expression of the characteristic function associated to the risk neutral probability density. This expression allows us to compute option prices exploiting a formula derived by Lewis and Lipton. We analyze in detail the case of Plain Vanilla calls, being liquid instruments for which reliable implied volatility surfaces are available. We also compute the analytical expressions of the first four cumulants, that are crucial to implement a simple two steps calibration procedure. It has been tested against a data set of options traded on the Milan Stock Exchange. The data analysis that we present reveals a good fit with the market implied surfaces and corroborates the accuracy of the linear approximation.

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Cites work

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Cited in

(5)

• Graphical modeling of stochastic processes driven by correlated noise
• Option pricing in the model with stochastic volatility driven by Ornstein-Uhlenbeck process. Simulation
• Option Pricing in Stochastic Volatility Models of the Ornstein‐Uhlenbeck type
• Stochastic Volatility With an Ornstein–Uhlenbeck Process: An Extension
• Option pricing under stochastic volatility: the exponential Ornstein-Uhlenbeck model

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