In this article we propose an efficient Monte Carlo scheme for simulating the stochastic volatility model of Heston (1993) enhanced by a non-parametric local volatility component. This hybrid model combines the main advantages of the Heston model and the local volatility model introduced by Dupire (1994) and Derman & Kani (1998). In particular, the additional local volatility component acts as a "compensator" that bridges the mismatch between the non-perfectly calibrated Heston model and the market quotes for European-type options. By means of numerical experiments we show that our scheme enables a consistent and fast pricing of products that are sensitive to the forward volatility skew. Detailed error analysis is also provided.
Additional Metadata
Keywords Heston Stochastic-Local Volatility, HSLV, Stochastic Volatility, Local Volatility, Heston, Hybrid Models, Calibration, Monte Carlo
THEME Other (theme 6)
Publisher World Scientific
Persistent URL
Journal International Journal of Theoretical and Applied Finance
Project Accurate pricing and calibration of models with stochastic volatility
van der Stoep, A.W, Grzelak, L.A, & Oosterlee, C.W. (2014). The Heston Stochastic-Local Volatility Model: Efficient Monte Carlo Simulation. International Journal of Theoretical and Applied Finance, 17(7). doi:10.1142/S0219024914500459