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

28 Pages Posted: 14 Jun 2016

See all articles by Gabriel G. Drimus

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 Zürich

Elise Gourier

ESSEC Business School

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Date Written: May 18, 2016

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. Under general stochastic volatility dynamics, we analyze the discretization effect and obtain an analytical correction term to be applied to the value of options on continuously sampled variance. The result allows for a straightforward implementation in many of the standard stochastic volatility models proposed in the literature. Finally, we compare the performance of different numerical methods for pricing options on discretely sampled variance and give recommendations based on the option’s characteristics.

Keywords: options on realized variance, variance swaps, stochastic volatility, discrete sampling, numerical pricing methods

Suggested Citation

Drimus, Gabriel G. and Farkas, Walter and Gourier, Elise, Valuation of Options on Discretely Sampled Variance: A General Analytic Approximation (May 18, 2016). Journal of Computational Finance, Vol. 20, No. 2, 2016. Available at SSRN: https://ssrn.com/abstract=2794922

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 Zürich ( 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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