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Application of Heston’s Model to the Chinese Stock Market

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  • Guifang Liu
  • Weijun Xu

Abstract

This article applies Heston’s (1993) stochastic volatility model to the Chinese stock market indices and subsequently assesses its pricing performance. A two-step estimation procedure is adopted to calibrate Heston’s model. First, we find that the option price is affected by both the moneyness and the maturity. Second, Heston’s model is more likely to overprice options, whereas the BS model tends to underestimate options. Finally, Heston’s model, by employing volatility as a random process, significantly improves the pricing accuracy compared to the BS model. Therefore, Heston’s model is tractable to analyze the Chinese stock market indices, and there is volatility risk that must not be overlooked in the Chinese stock market.

Suggested Citation

  • Guifang Liu & Weijun Xu, 2017. "Application of Heston’s Model to the Chinese Stock Market," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 53(8), pages 1749-1763, August.
    • Handle: RePEc:mes:emfitr:v:53:y:2017:i:8:p:1749-1763
    DOI: 10.1080/1540496X.2016.1219849
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