The valuation of variance swaps under stochastic volatility, stochastic interest rate and full correlation structure

DOI10.4134/JKMS.J190616MaRDI QIDQ5146449zbMATH OpenOpenAlexFDO

Authors Jiling Cao, Teh Raihana Nazirah Roslan, Wenjun Zhang

Publication date 25 January 2021

Full work available at URL https://arxiv.org/abs/1610.09714

zbMATH Keywords

generalized Fourier transformHeston-CIR hybrid modelrealized variancestochastic interest ratestochastic volatilityvariance swap

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Interest rates, asset pricing, etc. (stochastic models) (91G30)

Abstract: This paper considers the case of pricing discretely-sampled variance swaps under the class of equity-interest rate hybridization. Our modeling framework consists of the equity which follows the dynamics of the Heston stochastic volatility model, and the stochastic interest rate is driven by the Cox-Ingersoll-Ross (CIR) process with full correlation structure imposed among the state variables. This full correlation structure possess the limitation to have fully analytical pricing formula for hybrid models of variance swaps, due to the non-affinity property embedded in the model itself. We address this issue by obtaining an efficient semi-closed form pricing formula of variance swaps for an approximation of the hybrid model via the derivation of characteristic functions. Subsequently, we implement numerical experiments to evaluate the accuracy of our pricing formula. Our findings confirmed that the impact of the correlation between the underlying and the interest rate is significant for pricing discretely-sampled variance swaps.

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Cited in

(12)

• Stochastic pricing formulation for hybrid equity warrants
• A series-form solution for pricing variance and volatility swaps with stochastic volatility and stochastic interest rate
• Variance swaps under multiscale stochastic volatility of volatility
• Pricing variance swaps under double Heston stochastic volatility model with stochastic interest rate
• EQUILIBRIUM PRICE OF VARIANCE SWAPS UNDER STOCHASTIC VOLATILITY WITH LÉVY JUMPS AND STOCHASTIC INTEREST RATE
• COVARIANCE AND CORRELATION SWAPS FOR FINANCIAL MARKETS WITH MARKOV-MODULATED VOLATILITIES
• The Impact of Stochastic Volatility on Initial Margin and MVA for Interest Rate Derivatives
• VOLATILITY SWAPS VALUATION UNDER A MODIFIED RISK-NEUTRALIZED HESTON MODEL WITH A STOCHASTIC LONG-RUN VARIANCE LEVEL
• An analytic solution and an approximate solution for log-return variance swaps under double-mean-reverting volatility
• Credit default swap spreads modeling and forecasting with a stochastic square-root three-factor model
• Pricing exchange options under hybrid stochastic volatility and interest rate models
• Variance and volatility swap valuation with stochastic liquidity and regime switching stochastic volatility

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