# Improving control variate for variance reduction

I have tried stock price as control variate for my monte carlo simulation, and I am trying to reduce the variance of my estimated price for European Put option. And the code look like this:

path <- function(rho,T, S0, r, kappa, theta,xi,v0, Maturity ) {

dt = Maturity / T
COV <- matrix(c(1,rho,rho,1), nrow = 2,ncol = 2)
W <- rmvnorm(T, , COV)
W_v <- W[,1]
W_s <- W[,2]

Vt <- rep(0,T)
Vt[1] <- v0
St <- rep(0,T)
St[1] <- S0

for (i in 2:T){
Vt[i] <- Vt[i-1] + kappa* (theta - Vt[i-1])*dt + xi* sqrt(Vt[i-1]) * W_v[i-1] * sqrt(dt)
St[i] <- St[i-1]*exp((r-0.5*Vt[i-1]) *dt + sqrt(dt*Vt[i-1]) * W_s[i-1])

}
St
}
set.seed(214)
N<-2500
Stm <- replicate(100000, path(0.5,N,45,-0.02,10,0.09,0.2,0.09,2))
payoff <- pmax (40 - Stm[N,], 0 ) *exp(-0.02 * 2)
Hest_MC1 <- mean(payoff)
S_aver <- mean(Stm[N,])

ST <- 45* exp(-0.02 *2 )

hest_mc <- Hest_MC1 + -reg$coefficients[[2]]*(S_aver - ST) hest_mc reg <- lm(payoff~Stm[N,]) reg$coefficients

sd_old <- sqrt(var(payoff)/length(payoff))
sd_reduced <- sqrt(var(payoff)/length(payoff) + reg$$coefficients[[2]]^2 *var(Stm[N,])/length(Stm[N,]) + 2*( -reg$$coefficients[[2]] )*cov(Stm[N,],payoff)/length(payoff))
# result
sd_old sd_reduced
[1,] 0.06926151 0.04898853



As you can see, the result only improved marginally after 100,000 Simulation. Do anyone has any Idea how to continue improve on this? I did try the European Put (plain) as control variate, however, the payoff is very weakly correlated with the payoff of the option I tried to reduce variance on.

Any comment would be appreciated.

Quantitative Finance Asked by Lin Lex on December 31, 2020

Try a discretized form of the $$Put Delta*Stock increment$$, since the injection of this term should produce ideally (in the limit case) a 0 variance variable, namely the risk free drift.

Answered by Arshdeep Singh Duggal on December 31, 2020

## Related Questions

### Difference between Order Expire and Order Done for Day (DFD)

1  Asked on August 21, 2020 by abnv

### How to download full daily historical data of MSCI AC Asia Index

1  Asked on August 13, 2020 by monicam

### Implied Volatility from Heston Model

1  Asked on August 3, 2020