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European Option Pricing with Stochastic Volatility models under Parameter Uncertainty

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  • Samuel N. Cohen
  • Martin Tegn'er

Abstract

We consider stochastic volatility models under parameter uncertainty and investigate how model derived prices of European options are affected. We let the pricing parameters evolve dynamically in time within a specified region, and formalise the problem as a control problem where the control acts on the parameters to maximise/minimise the option value. Through a dual representation with backward stochastic differential equations, we obtain explicit equations for Heston's model and investigate several numerical solutions thereof. In an empirical study, we apply our results to market data from the S&P 500 index where the model is estimated to historical asset prices. We find that the conservative model-prices cover 98% of the considered market-prices for a set of European call options.

Suggested Citation

  • Samuel N. Cohen & Martin Tegn'er, 2018. "European Option Pricing with Stochastic Volatility models under Parameter Uncertainty," Papers 1807.03882, arXiv.org.
    • Handle: RePEc:arx:papers:1807.03882
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    References listed on IDEAS

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    Cited by:

    1. Olkhov, Victor, 2020. "Classical Option Pricing and Some Steps Further," MPRA Paper 105431, University Library of Munich, Germany, revised 28 Dec 2020.
    2. Olkhov, Victor, 2019. "New Essentials of Economic Theory," MPRA Paper 95065, University Library of Munich, Germany.
    3. Olkhov, Victor, 2019. "New Essentials of Economic Theory III. Economic Applications," MPRA Paper 94053, University Library of Munich, Germany.

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