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

Part of: Mathematical finance

Published online by Cambridge University Press:  26 September 2022

XIN-JIANG HE Open the ORCID record for XIN-JIANG HE [Opens in a new window]  and
SHA LIN Open the ORCID record for SHA LIN [Opens in a new window]
XIN-JIANG HE
Affiliation:
School of Economics, Zhejiang University of Technology, Hangzhou, China; e-mail: xinjiang@zjut.edu.cn
SHA LIN*
Affiliation:
School of Finance, Zhejiang Gongshang University, Hangzhou, China
*
e-mail: linsha@mail.zjgsu.edu.cn
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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.

Keywords

volatility swapsmodified Heston modelrisk-neutralized volatilitystochastic long-run varianceanalytical solution

MSC classification

Primary: 91G20: Derivative securities
Type
Research Article
Information
The ANZIAM Journal , Volume 64 , Issue 3 , July 2022 , pp. 250 - 263
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Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of Australian Mathematical Publishing Association Inc.

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