A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options

  title={A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options},
  author={Steven Heston},
  journal={Review of Financial Studies},
  • S. Heston
  • Published 1 April 1993
  • Economics
  • Review of Financial Studies
I use a new technique to derive a closed-form solution for the price of a European call option on an asset with stochastic volatility. The model allows arbitrary correlation between volatility and spot-asset returns. I introduce stochastic interest rates and show how to apply the model to bond options and foreign currency options. Simulations show that correlation between volatility and the spot asset's price is important for explaining return skewness and strike-price biases in the Black… 

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