Diffusion models of option pricing: Review of some local volatility models (LVM) and stochastic volatility models (SVM) with computational examples

Josheski, Dushko and Boskov, Tatjana (2023) Diffusion models of option pricing: Review of some local volatility models (LVM) and stochastic volatility models (SVM) with computational examples. Economic Development-Journal of the Institute of Economics Skopje, 25 (3). pp. 182-207. ISSN 1857-7741

Text DIFFUSION-MODELS-OF-OPTION-PRICING-REVIEW-OF-SOME.pdf Download (1MB)

Abstract

This paper is about financial models based on diffusion. And such models are represented by the Stochastic differential equation (SDE) driven by a Brownian motion. In this paper we are considering local volatility models and stochastic volatility models. These models are solving the shortcomings of Black-Scholes model namely by assuming that the volatility of the underlying price is a stochastic process rather than a constant, it becomes possible to model derivatives more accurately. Models like Carr-Madan and Black-Scholes Fourier pricing were presented before the previous two classes of models. In the class of stochastic volatility models SABR STOCHASTIC α,β,ρ model along with Heston model and displaced diffusion DD models are their main representatives in this paper. When it comes to market and model comparison this paper concludes that SABR model, Displaced diffusion (DD) model and Heston model are very close to market results, when it comes to implied volatility and strike price (SABR, DD) and Heston model are better when compared implied volatility with moneyness (strike price /spot price).

Item Type:	Article
Subjects:	Social Sciences > Economics and business
Divisions:	Faculty of Tourism and Business Logistics
Depositing User:	Dusko Josevski
Date Deposited:	16 Jan 2024 10:11
Last Modified:	16 Jan 2024 10:11
URI:	https://eprints.ugd.edu.mk/id/eprint/33148

Actions (login required)

View Item