Monte Carlo pricing in the Schöbel–Zhu model and its extensions

Alexander van Haastrecht, Roger Lord and Antoon Pelsser

Abstract

ABSTRACT

We propose a simulation algorithm for the Schöbel-Zhu model and its extension to include stochastic interest rates. Both schemes are derived by analyzing the lessons learned from Andersen's scheme on how to avoid the so-called leaking correlation phenomenon in the simulation of the Heston model. All introduced schemes are exponentially affine in expectation, which greatly facilitates the derivation of a martingale correction. In addition we study the regularity of each scheme. The numerical results indicate that our scheme consistently outperforms the Euler scheme. For a special case of the Schöbel-Zhu model which coincides with the Heston model, our scheme performs similarly to the QE-M scheme of Andersen. The results reaffirm that when simulating stochastic volatility models it is of the utmost importance to match the correlation between the asset price and the stochastic volatility process.