A Remark on a Singular Perturbation Method for Option Pricing under a Stochastic Volatility Model ( Forthcoming in “Asia-Pacific Financial Markets”. )

Abstract

This paper studies the accuracy of a singular perturbation method for option pricing under a stochastic volatility model ([8]). First, through numerical experiments we confirm that the first order approximation provides sufficiently accurate option prices in a fast mean-reversion case of the volatility process while it does not in a non-fast mean-reversion case. Then, we derive the second order approximation formula and examine the improvement of the approximation.