Consistent pricing of VIX and equity derivatives with the 4/2 stochastic volatility plus jumps model

DOI10.1016/J.JMAA.2016.10.039zbMATH Open1349.91279arXiv1510.01172OpenAlexW2963562428MaRDI QIDQ342905FDOQ342905

Authors: Wei Lin, Shane Chern, Xingguo Luo, Shenghong Li 

Publication date: 18 November 2016

Published in: Journal of Mathematical Analysis and Applications (Search for Journal in Brave)

Abstract: In this paper, we develop a 4/2 stochastic volatility plus jumps model, namely, a new stochastic volatility model including the Heston model and 3/2 model as special cases. Our model is highly tractable by applying the Lie symmetries theory for PDEs, which means that the pricing procedure can be performed efficiently. In fact, we obtain a closed-form solution for the joint Fourier-Laplace transform so that equity and realized-variance derivatives can be priced. We also employ our model to consistently price equity and VIX derivatives. In this process, the quasi-closed-form solutions for future and option prices are derived. Furthermore, through adopting data on daily VIX future and option prices, we investigate our model along with the Heston model and 3/2 model and compare their different performance in practice. Our result illustrates that the 4/2 model with an instantaneous volatility of the form $(asqrt{V}_t+b/sqrt{V}_t)$ for some constants $a,b$ presents considerable advantages in pricing VIX derivatives.

Full work available at URL: https://arxiv.org/abs/1510.01172

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zbMATH Keywords

stochastic volatilitytransform\(4/2\) modelVIX derivatives

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Applications of stochastic analysis (to PDEs, etc.) (60H30)

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Cited In (12)

• Sentiment-driven mean reversion in the 4/2 stochastic volatility model with jumps
• A multivariate 4/2 stochastic covariance model: properties and applications to portfolio decisions
• A novel term-structure-based Heston model for implied volatility surface
• Optimal DC pension investment with square-root factor processes under stochastic income and inflation risks
• Pure jump models for pricing and hedging VIX derivatives
• Pricing and hedging options in normal tempered stable process with 4/2 stochastic volatility
• Unifying pricing formula for several stochastic volatility models with jumps
• Pricing VIX derivatives with free stochastic volatility model
• Utility maximization in a stochastic affine interest rate and CIR risk premium framework: a BSDE approach
• European option pricing under the log mean-reverting jump diffusion stochastic volatility model
• EQUILIBRIUM PRICE OF VARIANCE SWAPS UNDER STOCHASTIC VOLATILITY WITH LÉVY JUMPS AND STOCHASTIC INTEREST RATE
• THE 4/2 STOCHASTIC VOLATILITY MODEL: A UNIFIED APPROACH FOR THE HESTON AND THE 3/2 MODEL

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