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

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

Lemmens, D;Wouters, M;Tempere, J;Foulon, S;
physical review e, statistical, nonlinear, and soft matter physics 2008 Vol. 78 pp. 016101
198
lemmens2008pathphysical

Abstract

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 analytical formulas are tested with numerical Monte Carlo simulations.

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