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2022•The ANZIAM JournalRequires access

VOLATILITY SWAPS VALUATION UNDER A MODIFIED RISK-NEUTRALIZED HESTON MODEL WITH A STOCHASTIC LONG-RUN VARIANCE LEVEL

Xin‐Jiang He, Sha Lin

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Abstract

Abstract We consider the pricing of discretely sampled volatility swaps under a modified Heston model, whose risk-neutralized volatility process contains a stochastic long-run variance level. We derive an analytical forward characteristic function under this model, which has never been presented in the literature before. Based on this, we further obtain an analytical pricing formula for volatility swaps which can guarantee the computational accuracy and efficiency. We also demonstrate the significant impact of the introduced stochastic long-run variance level on volatility swap prices with synthetic as well as calibrated parameters.

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What this paper is about

Abstract We consider the pricing of discretely sampled volatility swaps under a modified Heston model, whose risk-neutralized volatility process contains a stochastic long-run variance level. We derive an analytical forward characteristic function under this model, which has never been presented in the literature before. Based on this, we further obtain an analytical pricing formula for volatility swaps which can guarantee the computational accuracy and efficiency. We also demonstrate the significant impact of the introduced stochastic long-run variance level on volatility swap prices with synthetic as well as calibrated parameters.

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Available abstract

Abstract We consider the pricing of discretely sampled volatility swaps under a modified Heston model, whose risk-neutralized volatility process contains a stochastic long-run variance level. We derive an analytical forward characteristic function under this model, which has never been presented in the literature before. Based on this, we further obtain an analytical pricing formula for volatility swaps which can guarantee the computational accuracy and efficiency. We also demonstrate the significant impact of the introduced stochastic long-run variance level on volatility swap prices with synthetic as well as calibrated parameters.

Key concepts: Stochastic volatility, Variance swap, Heston model, Volatility swap, Forward volatility, Econometrics, Implied volatility, Volatility (finance)

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VOLATILITY SWAPS VALUATION UNDER A MODIFIED RISK-NEUTRALIZED HESTON MODEL WITH A STOCHASTIC LONG-RUN VARIANCE LEVEL — Research Paper | ScholarLens