Janek, Agnieszka and Kluge, Tino and Weron, Rafal and Wystup, Uwe (2010): FX Smile in the Heston Model.
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Abstract
The Heston model stands out from the class of stochastic volatility (SV) models mainly for two reasons. Firstly, the process for the volatility is nonnegative and meanreverting, which is what we observe in the markets. Secondly, there exists a fast and easily implemented semianalytical solution for European options. In this article we adapt the original work of Heston (1993) to a foreign exchange (FX) setting. We discuss the computational aspects of using the semianalytical formulas, performing Monte Carlo simulations, checking the Feller condition, and option pricing with FFT. In an empirical study we show that the smile of vanilla options can be reproduced by suitably calibrating three out of five model parameters.
Item Type:  MPRA Paper 

Original Title:  FX Smile in the Heston Model 
Language:  English 
Keywords:  Heston model; vanilla option; stochastic volatility; Monte Carlo simulation; Feller condition; option pricing with FFT 
Subjects:  C  Mathematical and Quantitative Methods > C6  Mathematical Methods; Programming Models; Mathematical and Simulation Modeling > C63  Computational Techniques; Simulation Modeling C  Mathematical and Quantitative Methods > C5  Econometric Modeling G  Financial Economics > G1  General Financial Markets > G13  Contingent Pricing; Futures Pricing 
Item ID:  25491 
Depositing User:  Rafal Weron 
Date Deposited:  28. Sep 2010 20:17 
Last Modified:  21. Feb 2013 22:15 
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URI:  http://mpra.ub.unimuenchen.de/id/eprint/25491 
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