Date of Award

12-2017

Degree Type

Thesis

Degree Name

Master of Science (MS)

Department

Economics and Finance

First Advisor

Tyler Brough

Second Advisor

Vicki Jones

Abstract

The 1973 Black-Scholes model, a revolutionary option pricing formula whose price is 'relatively close to observed prices, makes an assumption that the volatility is constant and thus, deterministic. This causes some inefficiencies and patterns in the pricing of options due to the model providing evidence of the volatility smile' of the volatility. Many scholars have suggested that the volatility should be modelled by a stochastic process and the (1993) Heston Model is one of many proposed solutions to remedy this problem. The Heston Model allows for the 'smile' by defining the volatility as a stochastic process. This thesis considers a solution to this problem by utilizing Heston’s stochastic volatility model in conjunction with Euler's discretization scheme in a simple Monte Carlo engine.

The application of this model has been implemented in object-oriented Cython, for it provides the simplicity of Python, all the while, providing C performance.

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