The evaluation of American compound option prices under stochastic volatility and stochastic interest rates

Chiarella, C; Kang, B

The evaluation of American compound option prices under stochastic volatility and stochastic interest rates

Chiarella, C Kang, B

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Publication Type:: Journal Article
Citation:: Journal of Computational Finance, 2013, 17 (1), pp. 71 - 92
Issue Date:: 2013-09-01

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Field	Value	Language
dc.contributor.author	Chiarella, C	en_US
dc.contributor.author	Kang, B	en_US
dc.date.issued	2013-09-01	en_US
dc.identifier.citation	Journal of Computational Finance, 2013, 17 (1), pp. 71 - 92	en_US
dc.identifier.issn	1460-1559	en_US
dc.identifier.uri	http://hdl.handle.net/10453/26036
dc.description.abstract	© 2013, Incisive Media Ltd. All rights reserved. A compound option (the mother option) gives the holder the right, but not the obligation, to buy (long) or sell (short) the underlying option (the daughter option). In this paper, we consider the problem of pricing American-type compound options when the underlying dynamics follow Heston’s stochastic volatility and with stochastic interest rate driven by Cox–Ingersoll–Ross processes. We use a partial differential equation (PDE) approach to obtain a numerical solution. The problem is formulated as the solution to a two-pass free-boundary PDE problem, which is solved via a sparse grid approach and is found to be accurate and efficient compared with the results from a benchmark solution based on a least-squares Monte Carlo simulation combined with the projected successive over-relaxation method.	en_US
dc.relation.ispartof	Journal of Computational Finance	en_US
dc.relation.isbasedon	10.21314/JCF.2013.264	en_US
dc.title	The evaluation of American compound option prices under stochastic volatility and stochastic interest rates	en_US
dc.type	Journal Article
utslib.citation.volume	1	en_US
utslib.citation.volume	17	en_US
utslib.for	0103 Numerical and Computational Mathematics	en_US
utslib.for	1502 Banking, Finance and Investment	en_US
utslib.for	0102 Applied Mathematics	en_US
pubs.embargo.period	Not known	en_US
pubs.organisational-group	/University of Technology Sydney
pubs.organisational-group	/University of Technology Sydney/Faculty of Business
pubs.organisational-group	/University of Technology Sydney/Faculty of Business/Finance Discipline
utslib.copyright.status	open_access
pubs.issue	1	en_US
pubs.publication-status	Published	en_US
pubs.volume	17	en_US

Abstract:

© 2013, Incisive Media Ltd. All rights reserved. A compound option (the mother option) gives the holder the right, but not the obligation, to buy (long) or sell (short) the underlying option (the daughter option). In this paper, we consider the problem of pricing American-type compound options when the underlying dynamics follow Heston’s stochastic volatility and with stochastic interest rate driven by Cox–Ingersoll–Ross processes. We use a partial differential equation (PDE) approach to obtain a numerical solution. The problem is formulated as the solution to a two-pass free-boundary PDE problem, which is solved via a sparse grid approach and is found to be accurate and efficient compared with the results from a benchmark solution based on a least-squares Monte Carlo simulation combined with the projected successive over-relaxation method.

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http://hdl.handle.net/10453/26036