A closed-form pricing formula for variance swaps with mean-reverting Gaussian volatility (Q2925697)

The author presents a new pricing formula for discretely sampled variance swaps based on the mean-reverting Gaussian volatility model. A closed-form exact solution for discretely sampled variance swaps with the realized variance -- defined as the sum of the percentage increment of the underlying asset price -- is derived, based on applying general asset valuation theory to obtain the associated PDE and then solving it. It is also demonstrated that the obtained pricing formula converges to that of its continuously monitored counterpart.