Valuation of Options on Discretely Sampled Variance: A General Analytic Approximation

The Journal of Computational Finance, Forthcoming

33 Pages Posted: 4 Nov 2010 Last revised: 10 Aug 2014

Gabriel G. Drimus

Institute of Banking and Finance, University of Zürich

Walter Farkas

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; ETH Zurich

Elise Gourier

ESSEC Business School

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2014

Abstract

The values of options on realized variance are significantly impacted by the discrete sampling of realized variance and may be substantially higher than the values of options on continuously sampled variance (or, quadratic variation). Under arbitrary stochastic volatility dynamics, we analyze the discretization effect and obtain a simple analytical correction term to be applied to the value of options on continuously sampled variance. Our final result is remarkably compact and allows for a straightforward implementation in many of the standard stochastic volatility models proposed in the literature.

Keywords: options on realized variance, variance swaps, stochastic volatility, Monte Carlo

JEL Classification: C63, G13

Suggested Citation

Drimus, Gabriel G. and Farkas, Walter and Gourier, Elise, Valuation of Options on Discretely Sampled Variance: A General Analytic Approximation (July 1, 2014). The Journal of Computational Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1700151 or http://dx.doi.org/10.2139/ssrn.1700151

Gabriel G. Drimus (Contact Author)

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

Plattenstrasse 14
Zürich, CH-8032
Switzerland

Walter Farkas

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland
+41-44-634 3953 (Phone)
+41-44-634 4345 (Fax)

HOME PAGE: http://https://people.math.ethz.ch/~farkas/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

ETH Zurich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Elise Gourier

ESSEC Business School ( email )

3 avenue Bernard Hirsch
Cergy-Pontoise, 95021
France

HOME PAGE: http://www.elisegourier.com

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