Evaluating the Predictive Accuracy of Heston Stochastic Volatility Model for Currency Options using Local and Global Calibration

This paper analyses the implementation and calibration of the Heston Stochastic Volatility Model. We first introduce the model, provides theoretical motivation for its robustness and hence popularity and explain how characteristic functions can be used to estimate option prices. Then we consider the implementation of the Heston model, showing that relatively simple solutions can lead to fast and accurate currency option prices. In this work, we perform several tests, using both local and global calibration to evaluate the Predictive Accuracy of the Heston Stochastic Volatility Model for currency options.Our analyses show that straightforward setups deliver excellent calibration results. All calculations are carried out in MATLAB and included in the paper. All the MATLAB’s codes required to implement the model are provided in the appendix A.