A STUDY OF OPTION PRICING MODELS WITH DISTINCT INTEREST RATES

Abstract

This paper analyses the effect of different interest rates on Black-Scholes’ and Heston Option Pricing Model. We discuss the concept of interest rate in the two Models. We compare the two models for the parameter –‘Interest Rate’. A mathematical tool, UMBRAE (Unscaled Mean Bounded Relative Absolute Error) is used to compare the two models for pricing European call options. NSE (National Stock Exchange) is used for real market data and comparison is done through Moneyness (which is defined as the percentage difference of stock price and strike price) and Time-To-Maturity. Mathematical software – Matlab is used for all mathematical calculations. We observe that Black-Scholes’ model is preferred for lower interest rates than Heston options pricing model and vice-versa. This study is helpful in derivatives market.