Theoretical and Natural Science
- The Open Access Proceedings Series for Conferences
Theoretical and Natural Science
Vol. 38, 24 June 2024
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Evolution of option pricing models: From Black-Scholes to Heston and beyond
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Abstract
This essay explores the evolution of option pricing models, tracing their development from the foundational Black-Scholes model to more advanced frameworks such as the Heston model and beyond. Beginning with an introduction to option pricing theory, the essay discusses the origins of the Black-Scholes model and its assumptions, as well as the challenges and limitations it faces. It then examines the extension of the Black-Scholes model, so-called the Black-Scholes-Merton model. It incorporates dividends, and lays the groundwork for further research into options pricing and financial derivatives. Then various stochastic volatility models emerge, and the essay chooses the Heston model as a typical example for analysis, highlighting its advantages and applications in option pricing. Furthermore, the essay compares the Heston model with other option pricing models, including the SABR model and Bates model. At the end of the essay, recent advances and future directions in option pricing are introduced and discussed. Through this comprehensive exploration, readers can gain a deeper understanding of the evolution of option pricing models and their significance in modern finance.
Keywords
Option pricing, Black-Scholes model, Black-Scholes-Merton model, Heston model, Stochastic volatility
References
1. Black, F., & Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy, 81(3), 637-654.
2. Heston, S. L. (1993). A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options. Review of Financial Studies, 6(2), 327-343.
3. Hull, J. C. (2018). Options, Futures, and Other Derivatives (10th ed.). Pearson.
4. McDonald, R. L. (2013). Derivatives Markets (3rd ed.). Pearson.
5. Wilmott, P. (2006). Paul Wilmott Introduces Quantitative Finance. John Wiley & Sons.
6. Derman, E., & Kani, I. (1994). Riding on the smile. Risk, 7(2), 32-39.
7. Ivanov RV. (2023). On the Stochastic Volatility in the Generalized Black-Scholes-Merton Model. Risks, 11(6), 111.
8. Yulu Guo. (2023). Option Margin Pattern Design based on Heston Model. Journal of Zhejiang University of Science and Technology, 35(3), 44-49.
9. Kexin Yun. (2022). Applications of Option Pricing Models in Risk Management. China securities and futures, 23, 23-27.
10. Lijuan Zhang. & Wenyong Zhang. (2018). Research on Hybrid Neural Network Option Pricing Model and Genetic Neural Algorithm Optimization. Journal of management engineering, 32(3), 19-21.
Data Availability
The datasets used and/or analyzed during the current study will be available from the authors upon reasonable request.
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- Volume Title
- Proceedings of the 2nd International Conference on Mathematical Physics and Computational Simulation
- ISBN (Print)
- 978-1-83558-461-3
- ISBN (Online)
- 978-1-83558-462-0
- Published Date
- 24 June 2024
- Series
- Theoretical and Natural Science
- ISSN (Print)
- 2753-8818
- ISSN (Online)
- 2753-8826
- DOI
- 10.54254/2753-8818/38/20240558
- Copyright
- 24 June 2024
- Open Access
- This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited