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Pricing Asian options with stochastic volatility

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  • Jean-Pierre Fouque
  • Chuan-Hsiang Han

Abstract

In this paper, we generalize the recently developed dimension reduction technique of Vecer for pricing arithmetic average Asian options. The assumption of constant volatility in Vecer's method will be relaxed to the case that volatility is randomly fluctuating and is driven by a mean-reverting (or ergodic) process. We then use the fast mean-reverting stochastic volatility asymptotic analysis introduced by Fouque, Papanicolaou and Sircar to derive an approximation to the option price which takes into account the skew of the implied volatility surface. This approximation is obtained by solving a pair of one-dimensional partial differential equations.

Suggested Citation

  • Jean-Pierre Fouque & Chuan-Hsiang Han, 2003. "Pricing Asian options with stochastic volatility," Quantitative Finance, Taylor & Francis Journals, vol. 3(5), pages 353-362.
    • Handle: RePEc:taf:quantf:v:3:y:2003:i:5:p:353-362
    DOI: 10.1088/1469-7688/3/5/301
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    References listed on IDEAS

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    1. B. LeBaron, 2001. "Stochastic volatility as a simple generator of apparent financial power laws and long memory," Quantitative Finance, Taylor & Francis Journals, vol. 1(6), pages 621-631.
    2. Blake LeBaron, 2001. "Volatility," Computing in Economics and Finance 2001 108, Society for Computational Economics.
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