On the pricing of double barrier options under stochastic volatility models: A probabilistic approach
We study the pricing of double barrier knock-out options under stochastic volatility using a conditional Monte Carlo method based on the local time-space formula of Peskir. A valuation formula including an early knock-out discount is provided, where the discount depends on the local time of the underlying stochastic processes and the deltas of the option at the barriers. The latter solve a system of coupled Volterra integral equations of the first kind. This characterization leads to an efficient numerical method for general volatility diffusion models. An algorithm for numerical implementation, based on a conditional quasi-Monte Carlo simulation method, is presented and shown to converge numerically to the true value of the claim. A numerical study is performed to illustrate properties of double barrier knock-out calls in the Heston stochastic volatility model. In our calibration, we find that short-dated (long-dated) at-the-money (ATM) knock-out call prices increase (decrease) when the speed of mean reversion increases, long run mean volatility increases, and vol-of-vol decreases. We also find that the deltas and vegas of short-dated ATM double barrier calls can be very sensitive to volatility in contrast to long-dated ones.
Authors
- Yerkin Kitapbayev (ORCID: https://orcid.org/0000-0002-4215-699X)
- Jérôme Detemple (ORCID: https://orcid.org/0000-0003-1173-6374)
- Danila Shabalin
Institutions
- Boston University (US)
- Khalifa University of Science and Technology (AE)
- Lomonosov Moscow State University (RU)
- Voronezh Research Institute Vega (RU)
Publication Details
- Journal
- AIMS Mathematics
- Published
- 2025-01-01
- DOI
- https://doi.org/10.3934/math.20251007
- Primary Topic
- Stochastic processes and financial applications
- Type
- article
- Field-Weighted Citation Impact
- 0.00