Pricing European Options Under Stochastic Volatilities Models
Interested by the volatility behavior, different models have been developed for option pricing. Starting from constant volatility model which did not succeed on capturing the effects of volatility smiles and skews; stochastic volatility models appear as a response to the weakness of the constant volatility models. Constant elasticity of volatility, Heston, Hull and White, Schöbel–Zhu, Schöbel–Zhu–Hull–White and many others are examples of models where the volatility is itself a random process. Along the chapter we deal with this class of models and we present the techniques of pricing European options. Comparing single factor stochastic volatility models to constant factor volatility models it seems evident that the stochastic volatility models represent nicely the movement of the asset price and its relations with changes in the risk. However, these models fail to explain the large independent fluctuations in the volatility levels and slope. Christoffersen et al. (Manag Sci 22(12):1914–1932, 2009, ) proposed a model with two-factor stochastic volatilities where the correlation between the underlying asset price and the volatilities varies randomly. In the last section of this chapter we introduce a variation of Chiarella and Ziveyi model, which is a subclass of the model presented in  and we use the first order asymptotic expansion methods to determine the price of European options.
KeywordsFinancial markets Option pricing Stochastic volatilities Asymptotic expansion
This work was partially supported by Swedish SIDA Foundation International Science Program. Betuel Canhanga and Jean-Paul Murara thanks Division of Applied Mathematics, School of Education, Culture and Communication, Mälardalen University for creating excellent research and educational environment.
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