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The affine Heston model with correlated Gaussian interest rates for pricing hybrid derivatives |
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| Authors: | Lech A. Grzelak Cornelis W. Oosterlee Sacha Van Weeren |
| Affiliation: | 1. Delft Institute of Applied Mathematics , Delft University of Technology , Delft , The Netherlands;2. Rabobank International , Utrecht , The Netherlands l.a.grzelak@tudelft.nl;4. CWI—Centrum Wiskunde &5. Informatica , Amsterdam , The Netherlands;6. Rabobank International , Utrecht , The Netherlands |
| Abstract: | In this article we define a multi-factor equity–interest rate hybrid model with non-zero correlation between the stock and interest rate. The equity part is modeled by the Heston model and we use a Gaussian multi-factor short-rate process. By construction, the model fits in the framework of affine diffusion processes, allowing fast calibration to plain vanilla options. We also provide an efficient Monte Carlo simulation scheme. |
| Keywords: | Hybrid stochastic model Heston–Gaussian multi-factor equity–interest rate model Affine diffusion process Characteristic function Unbiased Monte Carlo simulation |