Efficient, almost exact simulation of the Heston stochastic volatility model

We deal with several ecient discretization methods for the simulation of the Heston stochastic volatility model. The resulting schemes can be used to calculate all kind of options and correspondingsensitivities, in particular the exotic options that cannot be valued with closed-form solutions. We focus on to the (computational) efficiency of the simulation schemes: though theBroadie and Kaya (2006) paper provided an exact simulation method for the Heston dynamics, we argue why its practical use might be limited. Instead we consider efficient approximations ofthe exact scheme, which try to exploit certain distributional features of the underlying variance process. The resulting methods are fast, highly accurate and easy to implement. We conclude bynumerically comparing our new schemes to the exact scheme of Broadie and Kaya, the almost exact scheme of Smith, the Kahl-Jäckel scheme, the Full Truncation scheme of Lord et al. and the Quadratic Exponential scheme of Andersen.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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