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Stochastic Volatility: Option Pricing using a Multinomial Recombining Tree
Applied Mathematical Finance
In this article we treat the problem of option pricing when the volatility component of the underlying asset price is stochastic. The basic model we consider is commonly known as the Stochastic Volatility model: where Y t is an exogenous mean-reverting-type process. We seek a discrete approximation of this model, one that will converge in distribution to the above continuous model, and that will allow us to calculate the option price numerically. First, we show how to estimate the distributiondoi:10.1080/13504860701596745 fatcat:2a3sxhfqkjfbfctw4nxobxj7ia