VOLATILITY SWAPS VALUATION UNDER A MODIFIED RISK-NEUTRALIZED HESTON MODEL WITH A STOCHASTIC LONG-RUN VARIANCE LEVEL

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VOLATILITY SWAPS VALUATION UNDER A MODIFIED RISK-NEUTRALIZED HESTON MODEL WITH A STOCHASTIC LONG-RUN VARIANCE LEVEL

HE, XIN-JIANG; LIN, SHA

The ANZIAM journal, 07/2022, Volume: 64, Issue: 3

Journal Article

We consider the pricing of discretely sampled volatility swaps under a modified Heston model, whose risk-neutralized volatility process contains a stochastic long-run variance level. We derive an analytical forward characteristic function under this model, which has never been presented in the literature before. Based on this, we further obtain an analytical pricing formula for volatility swaps which can guarantee the computational accuracy and efficiency. We also demonstrate the significant impact of the introduced stochastic long-run variance level on volatility swap prices with synthetic as well as calibrated parameters.

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