Pricing variance swaps on time-changed Markov processes

DOI10.1137/20M1344597zbMATH Open1467.91180arXiv1705.01069MaRDI QIDQ4999901FDOQ4999901

Authors:

Publication date: 5 July 2021

Published in: SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Abstract: We prove that the variance swap rate (fair strike) equals the price of a co-terminal European-style contract when the underlying is an exponential Markov process, time-changed by an arbitrary continuous stochastic clock, which has arbitrary correlation with the driving Markov process, provided that the payoff function $G$ of the European contract satisfies an ordinary integro-differential equation, which depends only on the dynamics of the Markov process, not on the clock. We present examples of Markov processes where the function $G$ that prices the variance swap can be computed explicitly. In general, the solutions $G$ are not contained in the logarithmic family previously obtained in the special case where the Markov process is a L'evy process.

Full work available at URL: https://arxiv.org/abs/1705.01069

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zbMATH Keywords

Markov processvariance swaptime changeintegro-differential

Mathematics Subject Classification ID

Applications of continuous-time Markov processes on discrete state spaces (60J28) Derivative securities (option pricing, hedging, etc.) (91G20)

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Cited In (8)

• Title not available (Why is that?)
• Variation and share-weighted variation swaps on time-changed Lévy processes
• Pricing swaps and options on quadratic variation under stochastic time change models -- discrete observations case
• THE VARIANCE SWAP CONTRACT UNDER THE CEV PROCESS
• COVARIANCE AND CORRELATION SWAPS FOR FINANCIAL MARKETS WITH MARKOV-MODULATED VOLATILITIES
• Modeling and pricing of variance and volatility swaps for local semi-Markov volatilities in financial engineering
• Variance swaps on time-changed Lévy processes
• Pricing of variance and volatility swaps with semi-Markov volatilities

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