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A decomposition formula for option prices in the Heston model and applications to option pricing approximation
Alòs, Elisa
Universitat Pompeu Fabra. Departament d'Economia i Empresa
By means of classical Itô's calculus we decompose option prices asthe sum of the classical Black-Scholes formula with volatility parameterequal to the root-mean-square future average volatility plus a term dueby correlation and a term due to the volatility of the volatility. Thisdecomposition allows us to develop first and second-order approximationformulas for option prices and implied volatilities in the Heston volatilityframework, as well as to study their accuracy. Numerical examples aregiven.
13-05-2010
Statistics, Econometrics and Quantitative Methods
stochastic volatility
heston model
itô's calculus.
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