English

Option pricing under stochastic volatility: the exponential Ornstein-Uhlenbeck model

Pricing of Securities 2008-12-02 v2 Computational Physics Physics and Society

Abstract

We study the pricing problem for a European call option when the volatility of the underlying asset is random and follows the exponential Ornstein-Uhlenbeck model. The random diffusion model proposed is a two-dimensional market process that takes a log-Brownian motion to describe price dynamics and an Ornstein-Uhlenbeck subordinated process describing the randomness of the log-volatility. We derive an approximate option price that is valid when (i) the fluctuations of the volatility are larger than its normal level, (ii) the volatility presents a slow driving force toward its normal level and, finally, (iii) the market price of risk is a linear function of the log-volatility. We study the resulting European call price and its implied volatility for a range of parameters consistent with daily Dow Jones Index data.

Keywords

Cite

@article{arxiv.0804.2589,
  title  = {Option pricing under stochastic volatility: the exponential Ornstein-Uhlenbeck model},
  author = {Josep Perello and Ronnie Sircar and Jaume Masoliver},
  journal= {arXiv preprint arXiv:0804.2589},
  year   = {2008}
}

Comments

26 pages, 6 colored figures

R2 v1 2026-06-21T10:31:36.661Z