Analytic Pricing of Volatility-Equity Options within Affine Models: An Efficient Conditioning Technique
26 Pages Posted: 24 Apr 2014 Last revised: 16 Jan 2015
Date Written: January 16, 2015
We price for different affine stochastic volatility models some derivatives that recently appeared in the market. These products are characterised by payoffs depending on both stock and its volatility. Using a Fourier-analysis approach, we recover in a much simpler way some results already established in the literature for the single factor specification of the volatility and we push forward our methodology, which turns out to be independent of the dimension of the problem, thanks to a simple conditioning with respect to the subfiltration generated by the variance path. For each product we provide a closed form solution based on the Fast Fourier Transform and we illustrate the results for realistic model parameter values. Also, our results highlight the great flexibility and tractability of the Wishart based stochastic volatility models.
Keywords: Finance, Target Volatility Options, Corridor Variance Swap, Double Digital Call, Affine Stochastic Volatility Models
JEL Classification: G13
Suggested Citation: Suggested Citation