Lifted Heston Model: Efficient Monte Carlo Simulation with Large Time Steps

The lifted Heston model is a stochastic volatility model emerging as a Markovian lift of the rough Heston model and the class of rough volatility processes. The model encodes the path dependency of volatility on a set of N square-root state processes driven by a common stochastic factor. While the system is Markovian, simulation schemes such as the Euler scheme exist, but require a small-step, multidimensional simulation of the state processes and are therefore numerically challenging. We propose a novel simulation scheme of the class of implicit integrated variance schemes. The method exploits the near-linear nature between the stochastic driver and the conditional integrated variance process, which allows for a consistent and efficient sampling of the integrated variance process using an inverse Gaussian distribution. Since we establish the linear relation using a linear projection in the L2 space, the method is optimal in an L2 sense and offers a significant efficiency gain over similar methods. We demonstrate that our scheme achieves near-exact accuracy even for coarse discretizations and allows for efficient pricing of volatility options with large time steps.