I am attempting a MC simulation using GARCH(1,1) volatility model. I am not trying to estimate parameters as these have been given (Ritchken & Trevor (1999)). I am just trying to achieve the correct result. I have obtained the expected variance using the information in (Hull, 2005) shown below:

**From: Options, Futures and Other Derivatives (Hull, 2005)**

**( Evolution of sigma(t+1) )**

__GARCH(1,1) Volatility__:

\(\sigma^2_{n} = \gamma V_{L} + \alpha u^{2}_{n-1} +\beta \sigma^{2}_{n-1}\)

__where:__

(\(\gamma = 1 - \alpha - \beta\))

\(\sigma^2_{n} = (1 - \alpha -\beta)V_{L} + \alpha u^{2}_{n-1} +\beta \sigma^{2}_{n-1}\)

__Where the long term variance (\(V_{L}\)):__

\(V_{L} = \frac{\omega}{1 - \alpha -\beta}\)

__and the Return (\(u_{n-1}\)):__

\(u_{n-1} = \frac{S_{n-1} - S_{n-2}}{S_{n-2}}\)

__The expected variance (\(E[\sigma^2_{n+1}]\)):__

\(E[\sigma^2_{n+1}] = V_{L} + (\alpha + \beta)(\sigma^{2}_{n} - V_{L}\))

I am then trying to use the equation given by Duan(1995) for the stock price evolution:

**From: Duan (1995)**

**( Evolution of the stock price S(t+1) )**Using the Locally Risk-Neutral Valuation Relationship (LRNVR), the dynamics in the equivalent martingale measure is given by:

\(ln \frac{S_{t+1}}{S_{t}} = r - \frac{1}{2}\sigma_{n} +\widetilde{\varepsilon}_{t} \)

__where:__

\(\widetilde{\varepsilon}_{t}\) ~ \(N(0,\sigma_{n})\)

However, this does not produce the correct result. My question is, is the equation above the correct one for the evolution of the stock price under GARCH(1,1) volatility? I cannot seem to find any other equation.

**From: Ritchken & Trevor (1999) (The option I am trying to price)**

American Put Option Price:

Interest rate (r) is fixed at 10% (annualized using 365 days a year).

Stock price (S) is 100.

Time is (T = 100 days).

ω = 0.06575 (as we are working with returns in percentage terms)

α = 0.04

β = 0.90

γ = 0.00

λ = 0.00

Option Price: 3.143

Many thanks,

Hob