Option Pricing with Stochastic Volatility
Date Issued
2006
Date
2006
Author(s)
Chu, Yung-Chi
DOI
en-US
Abstract
The volatility smile is frequently observed in options prices. But in the pure Black-Scholes world, there should not be any smile as the volatility should be constant across the strike price and time. The Black-Scholes model makes the strong assumption that stock returns are normally distributed with known variance, but the constant variance assumption is somewhat simplisitc.
Pricing models with stochastic volatility have been addressed in the literature by many authors. The bivariate binomial framework presented by Hilliard and Schwartz [1996] not only allows non-zero correlation between the volatility and the underlying process but can also be used to value American options. This thesis fills that gap by implementing the bivariate binomial tree method to price options.
Subjects
stochastic volatility
Type
thesis
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