Option pricing under normal dynamics with stochastic volatility

In this paper, we derive the price of a European call option of an asset following a normal process assuming stochastic volatility. The volatility is assumed to follow the Cox Ingersoll Ross (CIR) process. We then use the fast Fourier transform (FFT) to evaluate the option price given we know the ch...

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Bibliographic Details
Published in:arXiv.org 2019-10
Main Author: Matta Uma Maheswara Reddy
Format: Article
Language:English
Subjects:
Characteristic functions
Computer simulation
Fast Fourier transformations
Fourier transforms
Monte Carlo simulation
Volatility
Online Access:Get full text
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Summary:In this paper, we derive the price of a European call option of an asset following a normal process assuming stochastic volatility. The volatility is assumed to follow the Cox Ingersoll Ross (CIR) process. We then use the fast Fourier transform (FFT) to evaluate the option price given we know the characteristic function of the return analytically. We compare the results of fast Fourier transform with the Monte Carlo simulation results of our process. Further, we present a numerical example to understand the normal implied volatility of the model.
ISSN:2331-8422