On pricing Asian options under stochastic volatility

This article presents a lattice model suitable forpricing European and American Asian options based on the arithmeticor geometric average of the underlying asset prices in a stochasticvolatility framework. The model is flexible enough to accommodatedifferent specifications of the squared volatility and asset priceprocesses. The squared volatility process is discretized by abinomial lattice. Then, a subset of asset price realizations and asubset of averages are attached to each node of the squaredvolatility lattice to cover the range of possible asset prices andaverages, respectively, at each time slice. Since the model works onrepresentative values, a double linear interpolation technique isused when solving backward through the tree to find the initialvalue of the Asian option. Extensive numerical experiments confirmthe accuracy and efficiency of the proposed model.