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Theoretical and Empirical Validation of Heston Model

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  • Zheng Cao
  • Xinhao Lin

Abstract

This study focuses on the application of the Heston model to option pricing, employing both theoretical derivations and empirical validations. The Heston model, known for its ability to incorporate stochastic volatility, is derived and analyzed to evaluate its effectiveness in pricing options. For practical application, we utilize Monte Carlo simulations alongside market data from the Crude Oil WTI market to test the model's accuracy. Machine learning based optimization methods are also applied for the estimation of the five Heston parameters. By calibrating the model with real-world data, we assess its robustness and relevance in current financial markets, aiming to bridge the gap between theoretical finance models and their practical implementations.

Suggested Citation

  • Zheng Cao & Xinhao Lin, 2024. "Theoretical and Empirical Validation of Heston Model," Papers 2409.12453, arXiv.org, revised Oct 2024.
    • Handle: RePEc:arx:papers:2409.12453
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    1. Jim Gatheral & Antoine Jacquier, 2014. "Arbitrage-free SVI volatility surfaces," Quantitative Finance, Taylor & Francis Journals, vol. 14(1), pages 59-71, January.
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