On Randomization of Affine Diffusion Processes with Application to Pricing of Options on VIX and S&P 500

The class of Affine (Jump) Diffusion (AD) has, due to its closed form characteristic function (ChF), gained tremendous popularity among practitioners and researchers. However, there is clear evidence that a linearity constraint is insufficient for precise and consistent option pricing. Any non-affine model must pass the strict requirement of quick calibration -- which is often challenging. We focus here on Randomized AD (RAnD) models, i.e., we allow for exogenous stochasticity of the model parameters. Randomization of a pricing model occurs outside the affine model and, therefore, forms a generalization that relaxes the affinity constraints. The method is generic and can apply to any model parameter. It relies on the existence of moments of the so-called randomizer- a random variable for the stochastic parameter. The RAnD model allows flexibility while benefiting from fast calibration and well-established, large-step Monte Carlo simulation, often available for AD processes. The article will discuss theoretical and practical aspects of the RAnD method, like derivations of the corresponding ChF, simulation, and computations of sensitivities. We will also illustrate the advantages of the randomized stochastic volatility models in the consistent pricing of options on the S&P 500 and VIX

The CTMC-Heston model: calibration and exotic option pricing with SWIFT

This work presents an efficient computational framework for pricing a general class of exotic and vanilla options under a versatile stochastic volatility model. In particular, we propose the use of a finite state continuous time Markov chain (CTMC) model, which closely approximates the classic Heston model but enables a simplified approach for consistently pricing a wide variety of financial derivatives (...

Stationary Heston model: Calibration and Pricing of exotics using Product Recursive Quantization

A major drawback of the Standard Heston model is that its implied volatility surface does not produce a steep enough smile when looking at short maturities. For that reason, we introduce the Stationary Heston model where we replace the deterministic initial condition of the volatility by its invariant measure and show, based on calibrated parameters, that this model produce a steeper smile for short maturities than the Standard Heston model. We also present numerical solution based on Product Recursive Quantization for the evaluation of exotic options (Bermudan and Barrier options)

The Randomized Heston Model

We propose a randomised version of the Heston model-a widely used stochastic volatility model in mathematical finance-assuming that the starting point of the variance process is a random variable. In such a system, we study the small- and large-time behaviours of the implied volatility, and show that the proposed randomisation generates a short-maturity smile much steeper (`with explosion') than in the standard Heston model, thereby palliating the deficiency of classical stochastic volatility models in short time. We precisely quantify the speed of explosion of the smile for short maturities in terms of the right tail of the initial distribution, and in particular show that an explosion rate of~tγ (γ∈[0,1/2]) for the squared implied volatility-as observed on market data-can be obtained by a suitable choice of randomisation. The proofs are based on large deviations techniques and the theory of regular variations