Estimating Option Prices with Heston ’ s Stochastic Volatility Model

An option is a security that gives the holder the right to buy or sell an asset at a specified price at a future time. This paper focuses on deriving and testing option pricing formulas for the Heston model [3], which describes the asset’s volatility as a stochastic process. Historical option data provides a basis for comparing the estimated option prices from the Heston model and from the popular Black-Scholes model. Root-mean-square error calculations find that the Heston model provides more accurate option pricing estimates than the Black-Scholes model for our data sample.