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Simulation of square-root processes made simple: applications to the Heston model

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  • Eduardo Abi Jaber

Abstract

We introduce a simple, efficient and accurate nonnegative preserving numerical scheme for simulating the square-root process. The novel idea is to simulate the integrated square-root process first instead of the square-root process itself. Numerical experiments on realistic parameter sets, applied for the integrated process and the Heston model, display high precision with a very low number of time steps. As a bonus, our scheme yields the exact limiting Inverse Gaussian distributions of the integrated square-root process with only one single time-step in two scenarios: (i) for high mean-reversion and volatility-of-volatility regimes, regardless of maturity; and (ii) for long maturities, independent of the other parameters.

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  • Eduardo Abi Jaber, 2024. "Simulation of square-root processes made simple: applications to the Heston model," Papers 2412.11264, arXiv.org.
    • Handle: RePEc:arx:papers:2412.11264
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    References listed on IDEAS

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    1. Bégin Jean-François & Bédard Mylène & Gaillardetz Patrice, 2015. "Simulating from the Heston model: A gamma approximation scheme," Monte Carlo Methods and Applications, De Gruyter, vol. 21(3), pages 205-231, September.
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    8. Eduardo Abi Jaber & Nathan De Carvalho, 2023. "Reconciling rough volatility with jumps," Papers 2303.07222, arXiv.org, revised Sep 2024.
    9. Eduardo Abi Jaber & Nathan de Carvalho, 2024. "Reconciling rough volatility with jumps," Post-Print hal-04295416, HAL.
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