Stock Evolution under Stochastic Volatility : A Discrete

This paper examines the pricing of options by approximating extensions of the Black{Scholes setup in which volatility follows a separate diiusion process. It generalizes the well{known binomial model, constructing a discrete two{ dimensional lattice. We discuss convergence issues extensively and calculate prices and implied volatilities for European{ and American{style put options. A Deutscher Akademischer Austauschdienst scholarship through HSP III (a joint program by the Federal and State Governments in Germany) is gratefully acknowledged.