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Rational Approximation Of The Rough Heston Solution

Author

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  • JIM GATHERAL

    (Department of Mathematics, Baruch College, CUNY, One Bernard Baruch Way, New York, NY 10010, USA)

  • RADOŠ RADOIČIĆ

    (Department of Mathematics, Baruch College, CUNY, One Bernard Baruch Way, New York, NY 10010, USA)

Abstract

Pricing in the rough Heston model of Jaisson & M. Rosenbaum [(2016) Rough fractional diffusions as scaling limits of nearly unstable heavy tailed Hawkes processes, The Annals of Applied Probability 26 (5), 2860–2882] requires the solution of a fractional Riccati differential equation, which is not known in explicit form. Though numerical schemes to approximate this solution do exist, they inevitably require significantly more time to compute than the closed-form solution in the classical Heston model. In this paper, we present a simple rational approximation to the solution of the rough Heston Riccati equation valid in a region of its domain relevant to option valuation. Pricing using this approximation is both fast and very accurate.

Suggested Citation

  • Jim Gatheral & Radoš Radoičić, 2019. "Rational Approximation Of The Rough Heston Solution," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(03), pages 1-19, May.
    • Handle: RePEc:wsi:ijtafx:v:22:y:2019:i:03:n:s0219024919500109
    DOI: 10.1142/S0219024919500109
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    References listed on IDEAS

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    1. Cang, Jie & Tan, Yue & Xu, Hang & Liao, Shi-Jun, 2009. "Series solutions of non-linear Riccati differential equations with fractional order," Chaos, Solitons & Fractals, Elsevier, vol. 40(1), pages 1-9.
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    3. Jim Gatheral & Martin Keller-Ressel, 2018. "Affine forward variance models," Papers 1801.06416, arXiv.org, revised Oct 2018.
    4. Eduardo Abi Jaber & Omar El Euch, 2018. "Multi-factor approximation of rough volatility models," Papers 1801.10359, arXiv.org, revised Apr 2018.
    5. Omar El Euch & Mathieu Rosenbaum, 2019. "The characteristic function of rough Heston models," Mathematical Finance, Wiley Blackwell, vol. 29(1), pages 3-38, January.
    6. Alan L. Lewis, 2000. "Option Valuation under Stochastic Volatility," Option Valuation under Stochastic Volatility, Finance Press, number ovsv, December.
    7. Eduardo Abi Jaber & Omar El Euch, 2018. "Multi-factor approximation of rough volatility models," Working Papers hal-01697117, HAL.
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    Citations

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    Cited by:

    1. Fabio Baschetti & Giacomo Bormetti & Silvia Romagnoli & Pietro Rossi, 2020. "The SINC way: A fast and accurate approach to Fourier pricing," Papers 2009.00557, arXiv.org, revised May 2021.
    2. Eduardo Abi Jaber, 2022. "The characteristic function of Gaussian stochastic volatility models: an analytic expression," Working Papers hal-02946146, HAL.
    3. Eduardo Abi Jaber, 2022. "The characteristic function of Gaussian stochastic volatility models: an analytic expression," Post-Print hal-02946146, HAL.
    4. Eduardo Abi Jaber, 2020. "The characteristic function of Gaussian stochastic volatility models: an analytic expression," Papers 2009.10972, arXiv.org, revised May 2022.
    5. Andrey Itkin, 2023. "The ATM implied skew in the ADO-Heston model," Papers 2309.15044, arXiv.org.
    6. Giorgia Callegaro & Martino Grasselli & Gilles Paèes, 2021. "Fast Hybrid Schemes for Fractional Riccati Equations (Rough Is Not So Tough)," Mathematics of Operations Research, INFORMS, vol. 46(1), pages 221-254, February.
    7. Jim Gatheral & Paul Jusselin & Mathieu Rosenbaum, 2020. "The quadratic rough Heston model and the joint S&P 500/VIX smile calibration problem," Papers 2001.01789, arXiv.org.
    8. Eduardo Abi Jaber, 2022. "The characteristic function of Gaussian stochastic volatility models: an analytic expression," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-02946146, HAL.
    9. Fabio Baschetti & Giacomo Bormetti & Pietro Rossi, 2023. "Deep calibration with random grids," Papers 2306.11061, arXiv.org, revised Jan 2024.

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