Application of Stochastic Volatility Models in Option Pricing

Bachelorarbeit aus dem Jahr 2010 im Fachbereich BWL - Investition und Finanzierung Note: 12 EBS Universität für Wirtschaft und Recht Sprache: Deutsch Abstract: The Black-Scholes (or Black-Scholes-Merton) Model has become the standard model for the pricing of options and can surely be seen as one of the main reasons for the growth of the derivative market after the model´s introduction in 1973. As a consequence the inventors of the model Robert Merton Myron Scholes and without doubt also Fischer Black if he had not died in 1995 were awarded the Nobel prize for economics in 1997.The model however makes some strict assumptions that must hold true for accurate pricing of an option. The most important one is constant volatility whereas empirical evidence shows that volatility is heteroscedastic. This leads to increased mispricing of options especially in the case of out of the money options as well as to a phenomenon known as volatility smile. As a consequence researchers introduced various approaches to expand the model by allowing the volatility to be non-constant and to follow a sto-chastic process. It is the objective of this thesis to investigate if the pricing accuracy of the Black-Scholes model can be significantly improved by applying a stochastic volatility model.