Pricing European and American options under Heston's stochastic volatility model with accelerated explicit finite differencing methods

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Title: Pricing European and American options under Heston's stochastic volatility model with accelerated explicit finite differencing methods
Authors: O'Sullivan, Conall
O'Sullivan, Stephen
Permanent link: http://hdl.handle.net/10197/2564
Date: Jun-2010
Abstract: We present an acceleration technique, effective for explicit finite difference schemes describing diffusive processes with nearly symmetric operators, called Super-Time- Stepping (STS). The technique is applied to the two-factor problem of option pricing under stochastic volatility. It is shown to significantly reduce the severity of the stability constraint known as the Courant-Friedrichs-Lewy condition whilst retaining the simplicity of the chosen underlying explicit method. For European and American put options under Heston’s stochastic volatility model we demonstrate degrees of acceleration over standard explicit methods sufficient to achieve comparable, or superior, efficiencies to a benchmark implicit scheme. We conclude that STS is a powerful tool for the numerical pricing of options and propose them as the method-of-choice for exotic financial instruments in two and multi-factor models.
Funding Details: Not applicable
Type of material: Working Paper
Publisher: University College Dublin. School of Business. Centre for Financial Markets
Series/Report no.: Centre for Financial Markets working paper series; WP 10 03
Subject LCSH: Acceleration principle (Economics)
Options (Finance)--Mathematical models
Financial instruments--Econometric models
Other versions: http://www.ucd.ie/bankingfinance/docs/wp/WP-10-03.pdf
Language: en
Status of Item: Not peer reviewed
Appears in Collections:Centre for Financial Markets Working Papers

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