A Decomposition Formula for Option Prices in the Heston Model and Applications to Option Pricing Approximation

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Alòs, Elisa. A Decomposition Formula for Option Prices in the Heston Model and Applications to Option Pricing Approximation. 2010

Title:	A Decomposition Formula for Option Prices in the Heston Model and Applications to Option Pricing Approximation
Author:	Alòs, Elisa
Other authors:	Universitat Pompeu Fabra. Departament d'Economia i Empresa
Abstract:	By means of classical Itô's calculus we decompose option prices as the sum of the classical Black-Scholes formula with volatility parameter equal to the root-mean-square future average volatility plus a term due by correlation and a term due to the volatility of the volatility. This decomposition allows us to develop first and second-order approximation formulas for option prices and implied volatilities in the Heston volatility framework, as well as to study their accuracy. Numerical examples are given.
Document type:	Working paper
Date:	2010
Rights:	Aquest document està subjecte a una llicència d'ús de Creative Commons, amb la qual es permet copiar, distribuir i comunicar públicament l'obra sempre que se'n citin l'autor original, la universitat i el departament i no se'n faci cap ús comercial ni obra derivada, tal com queda estipulat en la llicència d'ús (http://creativecommons.org/licenses/by-nc-nd/2.5/es/)