A path integral approach to closed-form option pricing formulas with applications to stochastic volatility and interest rate models

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Lemmens, D.
Wouters, M.
Tempere, J.
Foulon, S.
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Abstract
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We present a path integral method to derive closed-form solutions for option prices in a stochastic volatility model. The method is explained in detail for the pricing of a plain vanilla option. The flexibility of our approach is demonstrated by extending the realm of closed-form option price formulas to the case where both the volatility and interest rates are stochastic. This flexibility is promising for the treatment of exotic options. Our new analytical formulas are tested with numerical Monte Carlo simulations.
Keywords
Quantitative Finance - Pricing of Securities, Condensed Matter - Statistical Mechanics, Physics - Physics and Society
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