This is a joint event with the UConn Control and Optimization Seminar.

Abstract. We propose efficient and reliable simulation schemes for pricing options under the stochastic-alpha-beta-rho (SABR) model. The standard two-step simulation procedures involve (i) simulation of the integrated variance conditional on terminal variance and (ii) simulation of the terminal forward price conditional on terminal variance and integrated variance. Most simulation schemes rely on the Islah approximation formula of the conditional distribution of the terminal asset price, which is seen to fail the martingale condition in general. We embed three enhanced features in our proposed simulation schemes. Firstly, we approximate the terminal forward price as the constant elasticity of variance (CEV) process that satisfies the martingale condition, an important property that precludes arbitrage. Secondly, we adopt the displaced Poisson-mixture Gamma distribution for the exact simulation of the underlying CEV process in the simulation of the terminal forward price conditional on integrated variance and terminal variance. Thirdly, we use the shifted lognormal approximation of the integrated variance to compute the integrated variance. Our enhanced procedures avoid the tedious Laplace inversion algorithm in integrated variance calculations and non-efficient inverse transform in the forward price calculations in earlier simulation schemes. Numerical results demonstrate our simulation schemes to be highly efficient, accurate, and reliable.

Speaker’s short bio: Dr. Choi is an associate professor with tenure at Peking University HSBC Business School in Shenzhen, China. He obtained his PhD in applied mathematics from Massachusetts Institute of Technology in 2005 and BS in mathematics from the Korean Advanced Institute of Science Technology in 2000. After his PhD, he worked in the industry as a quant for several years in BNP Paribas and Goldman Sachs. His research interests include quantitative finance, mathematical modeling, numerical methods, and data science. Please visit his website https://english.phbs.pku.edu.cn/2016/fulltime_0826/81.html for more information.