On American VIX options under the generalized 3/2 and 1/2 models

DOI10.1111/MAFI.12153MaRDI QIDQ4642732zbMATH OpenOpenAlexFDO

Authors Yerkin Kitapbayev, Jérôme Detemple

Publication date 25 May 2018

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1606.00530

zbMATH Keywords

American optionsexercise boundariesexercise premiumgeneralized 3/2 and 1/2 modelsgeneralized mixture modelsintegral equationslocal timestochastic volatilityVIX

Mathematics Subject Classification ID

Stopping times; optimal stopping problems; gambling theory (60G40) Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: In this paper, we extend the 3/2-model for VIX studied by Goard and Mazur (2013) and introduce the generalized 3/2 and 1/2 classes of volatility processes. Under these models, we study the pricing of European and American VIX options and, for the latter, we obtain an early exercise premium representation using a free-boundary approach and local time-space calculus. The optimal exercise boundary for the volatility is obtained as the unique solution to an integral equation of Volterra type. We also consider a model mixing these two classes and formulate the corresponding optimal stopping problem in terms of the observed factor process. The price of an American VIX call is then represented by an early exercise premium formula. We show the existence of a pair of optimal exercise boundaries for the factor process and characterize them as the unique solution to a system of integral equations.

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(12)

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• Stochastic volatility models and the pricing of VIX options
• Recombining tree approximations for optimal stopping for diffusions
• Pricing and hedging of VIX options for Barndorff-Nielsen and Shephard models
• Foreign exchange option pricing under the 4/2 stochastic volatility model with CIR interest rates.
• Formulas for pricing American VIX options under the generalized mixture volatility models
• Stock market index dynamics and market activity
• Pricing formulas for American perpetual knock-out and callable volatility options
• The early exercise boundary under the jump to default extended CEV model

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