A Remark on a Singular Perturbation Method for Option Pricing Under a Stochastic Volatility Model |
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Authors: | Kyo Yamamoto Akihiko Takahashi |
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Affiliation: | 1. Graduate School of Economics, The University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo, 113-0033, Japan
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Abstract: | This paper studies the approximation accuracy of a singular perturbation method for option pricing up to the second order under a stochastic volatility model. First, numerical experiments confirm that the first order approximation provides sufficiently accurate option prices in a fast mean-reversion volatility case. On the other hand, it creates relatively large errors in a non-fast mean-reversion volatility environment. Then, the second order approximation formula is derived and the improvement of the approximation is investigated. |
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