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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, Swiss Finance Institute (SFI) at Department of Banking and Finance; ETH Zürich - Department of Mathematics

Elise Gourier

Queen Mary, University of London

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, Swiss Finance Institute (SFI) at Department of Banking and Finance ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland
+41-44-634 3953 (Phone)
+41-44-634 4345 (Fax)

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

ETH Zürich - Department of Mathematics ( email )

ETH Zentrum HG-F 42.1
Raemistr. 101
CH-8092 Zurich, 8092
Switzerland

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

Elise Gourier

Queen Mary, University of London ( email )

Mile End Road
London, E1 4NS
United Kingdom

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

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