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A Forward Started Jump-Diffusion Model and Pricing of Cliquet Style Exotics

17 Pages Posted: 4 Apr 2009 Last revised: 21 Dec 2010

Gabriel G. Drimus

Institute of Banking and Finance, University of Zürich

Date Written: October 30, 2008

Abstract

We present a two factor forward variance market model with jumps in returns and volatility. It allows the model user to directly control the behavior of future smiles and hence properly price forward smile risk of cliquet-style exotic products. The key idea, in order to achieve consistency between the dynamics of forward variance swaps and the underlying stock, is to adopt a forward starting model for the stock dynamics over each reset period of the tenor structure.

Keywords: forward volatility smiles, forward skew, variance swaps, cliquets, exotic options

JEL Classification: G13

Suggested Citation

Drimus, Gabriel G., A Forward Started Jump-Diffusion Model and Pricing of Cliquet Style Exotics (October 30, 2008). Review of Derivatives Research, Vol. 13, No. 2, 2010. Available at SSRN: https://ssrn.com/abstract=1373126

Gabriel G. Drimus (Contact Author)

Institute of Banking and Finance, University of Zürich ( email )

Plattenstrasse 14
Zürich, CH-8032
Switzerland

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