Convergence of an Euler Scheme for a Hybrid Stochastic-Local Volatility Model with Stochastic Rates in Foreign Exchange Markets

DOI10.1137/17M1114569zbMATH Open1408.91209arXiv1501.06084OpenAlexW2535824074MaRDI QIDQ4635245FDOQ4635245

Matthieu Mariapragassam, Andrei Cozma, C. Reisinger

Publication date: 16 April 2018

Published in: SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Abstract: We study the Heston-Cox-Ingersoll-Ross++ stochastic-local volatility model in the context of foreign exchange markets and propose a Monte Carlo simulation scheme which combines the full truncation Euler scheme for the stochastic volatility component and the stochastic domestic and foreign short interest rates with the log-Euler scheme for the exchange rate. We establish the exponential integrability of full truncation Euler approximations for the Cox-Ingersoll-Ross process and find a lower bound on the explosion time of these exponential moments. Under a full correlation structure and a realistic set of assumptions on the so-called leverage function, we prove the strong convergence of the exchange rate approximations and deduce the convergence of Monte Carlo estimators for a number of vanilla and path-dependent options. Then, we perform a series of numerical experiments for an autocallable barrier dual currency note.

Full work available at URL: https://arxiv.org/abs/1501.06084

zbMATH Keywords

Monte Carlo simulationcalibrationstrong convergenceHeston modelexponential integrabilityshifted square-root process

Mathematics Subject Classification ID

Monte Carlo methods (65C05) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Numerical methods for inverse problems for boundary value problems involving PDEs (65N21) Computational methods for stochastic equations (aspects of stochastic analysis) (60H35) Numerical solutions to stochastic differential and integral equations (65C30)

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Cited In (12)

• An adaptive Euler-Maruyama scheme for Mckean-Vlasov SDEs with super-linear growth and application to the mean-field Fitzhugh-Nagumo model
• Hybrid equity swap, cap, and floor pricing under stochastic interest by Markov chain approximation
• Convergence of an Euler Scheme for a Hybrid Stochastic-Local Volatility Model with Stochastic Rates in Foreign Exchange Markets
• A Shannon wavelet method for pricing foreign exchange options under the Heston multi-factor CIR model
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