Pricing Bermudan Variance Swaptions Using Multinomial Trees

The Journal of Derivatives Spring 2019, 26 (3) 22-34, http://jod.pm-research.com/content/26/3/22

Posted: 15 Jun 2018 Last revised: 5 Oct 2019

See all articles by Honglei Zhao

Honglei Zhao

Hanlon Financial Systems Lab; Stevens Institute of Technology

Rupak Chatterjee

Stevens Institute of Technology

Thomas Lonon

Stevens Institute of Technology

Ionut Florescu

Stevens Institute of Technology

Date Written: June 1, 2018

Abstract

In a recent study, we present a tree methodology to evaluate the expected generalized realized variance in a general stochastic volatility model. This provides an efficient way of calculating the fair value of the strike for variance swaps. In this article, we expand the methodology to price nonlinear derivatives written on realized variance. Particularly we introduce a new option contract a Bermudan variance swaption, defined as an option on variance swap with early exercise dates. Within the same framework, we also show how to value forward-start variance swaps, VIX futures and VIX options. Numerical tests show that the methodology introduced is efficient and accurate.

Keywords: variance swaption, stochastic volatility, multinomial tree

JEL Classification: C60, C52, C63

Suggested Citation

Zhao, Honglei and Chatterjee, Rupak and Lonon, Thomas and Florescu, Ionut, Pricing Bermudan Variance Swaptions Using Multinomial Trees (June 1, 2018). The Journal of Derivatives Spring 2019, 26 (3) 22-34, http://jod.pm-research.com/content/26/3/22. Available at SSRN: https://ssrn.com/abstract=3189120 or http://dx.doi.org/10.2139/ssrn.3189120

Honglei Zhao

Hanlon Financial Systems Lab ( email )

Hoboken, NJ 07030
United States

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Rupak Chatterjee

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Thomas Lonon

Stevens Institute of Technology ( email )

Hoboken, NJ 07030
United States

Ionut Florescu (Contact Author)

Stevens Institute of Technology ( email )

Castle Point on the Hudson
Hoboken, NJ 07030
United States

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