Spectral decomposition of option prices in fast mean-reverting stochastic volatility models

DOI10.1137/100803614MaRDI QIDQ5388679zbMATH OpenOpenAlexFDO

Authors Jean-Pierre Fouque, Sebastian Jaimungal, Matthew Lorig

Publication date 19 April 2012

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

Full work available at URL https://arxiv.org/abs/1007.4361

zbMATH Keywords

approximate pricefast mean-reversionoptionsspectral theorystochastic volatility

Mathematics Subject Classification ID

Numerical methods for eigenvalue problems for boundary value problems involving PDEs (65N25) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: Using spectral decomposition techniques and singular perturbation theory, we develop a systematic method to approximate the prices of a variety of options in a fast mean-reverting stochastic volatility setting. Four examples are provided in order to demonstrate the versatility of our method. These include: European options, up-and-out options, double-barrier knock-out options, and options which pay a rebate upon hitting a boundary. For European options, our method is shown to produce option price approximations which are equivalent to those developed in [5]. [5] Jean-Pierre Fouque, George Papanicolaou, and Sircar Ronnie. Derivatives in Financial Markets with Stochas- tic Volatility. Cambridge University Press, 2000.

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(16)

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• Pricing of options in the singular perturbed stochastic volatility model
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• Second order multiscale stochastic volatility asymptotics: stochastic terminal layer analysis and calibration
• A volatility-of-volatility expansion of the option prices in the SABR stochastic volatility model
• Model uncertainty in commodity markets
• Option price with stochastic volatility for both fast and slow mean-reverting regimes
• A general valuation framework for SABR and stochastic local volatility models
• Partial differential equation pricing of contingent claims under stochastic correlation
• Application of the spectral theory and perturbation theory to the study of Ornstein-Uhlenbeck processes
• On a semi-spectral method for pricing an option on a mean-reverting asset
• An analytical approximation method for pricing barrier options under the double Heston model
• Spectral methods for the calculation of risk measures for variable annuity guaranteed benefits
• Pricing derivatives on multiscale diffusions: an eigenfunction expansion approach
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