A tree-based method to price American options in the Heston model

Michel Vellekoop, Hans Nieuwenhuis

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    We develop an algorithm to price American options on assets that follow the stochastic volatility model defined by Heston. We use an approach which is based on a modification of a combined tree for stock prices and volatilities, where the number of nodes grows quadratically in the number of time steps. We show in a number of numerical tests that we get accurate results in a fast manner, and that features which are essential for the practical use of stock option pricing algorithms, such as the incorporation of cash dividends and a term structure of interest rates, can easily be incorporated.
    Original languageEnglish
    Pages (from-to)1-21
    Number of pages21
    JournalJournal of Computational Finance
    Issue number1
    Publication statusPublished - 2009


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