Ch. Kahl
http://repub.eur.nl/ppl/3604/
List of Publicationsenhttp://repub.eur.nl/eur_logo_new.png
http://repub.eur.nl/
RePub, Erasmus University RepositoryOptimal Fourier Inversion in Semi-analytical Option Pricing
http://repub.eur.nl/pub/7915/
Tue, 18 Jul 2006 00:00:01 GMT<div>R. Lord</div><div>Ch. Kahl</div>
At the time of writing this article, Fourier inversion is the computational method of choice for a fast and accurate calculation of plain vanilla option prices in models with an analytically available characteristic function. Shifting the contour of integration along the complex plane allows for different representations of the inverse Fourier integral. In this article, we present the optimal contour of the Fourier integral, taking into account numerical issues such as cancellation and explosion of the characteristic function. This allows for robust and fast option pricing for almost all levels of strikes and maturities.Why the Rotation Count Algorithm Works
http://repub.eur.nl/pub/7914/
Mon, 17 Jul 2006 00:00:01 GMT<div>R. Lord</div><div>Ch. Kahl</div>
The characteristic functions of many affine jump-diffusion models, such as Heston’s stochastic volatility model and all of its extensions, involve multivalued functions such as the complex logarithm. If we restrict the logarithm to its principal branch, as is done in most software packages, the characteristic function can become discontinuous, leading to completely wrong option prices if options are priced by Fourier inversion. In this paper we prove under non-restrictive conditions on the parameters that the rotation count algorithm of Kahl and Jäckel chooses the correct branch of the complex logarithm. Under the same restrictions we prove that in an alternative formulation of the characteristic function the principal branch is the correct one. Seen as this formulation is easier to implement and numerically more stable than Heston’s formulation, it should be the preferred one. The remainder of this paper shows how complex discontinuities can be avoided in the Schöbel-Zhu model and the exact simulation algorithm of the Heston model, recently proposed by Broadie and Kaya. Finally, we show that Matytsin’s SVJJ model has a closed-form characteristic function, though the complex discontinuities that arise there due to the branch switching of the exponential integral cannot be avoided under all circumstances.