Variance Swap with Mean Reversion, Multifactor Stochastic Volatility and Jumps

European Journal of Operational Research. 245, 571-580

38 Pages Posted: 23 Jun 2020

See all articles by Chi Seng Pun

Chi Seng Pun

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences

Shing Fung Chung

The Chinese University of Hong Kong (CUHK) - Department of Statistics

Hoi Ying Wong

The Chinese University of Hong Kong (CUHK) - Department of Statistics

Date Written: March 28, 2015

Abstract

This paper examines variance swap pricing using a model that integrates three major features of financial assets, namely the mean reversion in asset price, multi-factor stochastic volatility (SV) and simultaneous jumps in prices and volatility factors. Closed-form solutions are derived for vanilla variance swaps and gamma swaps while the solutions for corridor variance swaps and conditional variance swaps are expressed in a one-dimensional Fourier integral. The numerical tests confirm that the derived solution is accurate and efficient. Furthermore, empirical studies have shown that multi-factor SV models better capture the implied volatility surface from option data. The empirical results of this paper also show that the additional volatility factor contributes significantly to the price of variance swaps. Hence, the results favor multi-factor SV models for pricing variance swaps consistent with the implied volatility surface.

Keywords: Pricing, Variance Swap, Multi-factor Stochastic Volatility, Mean Reversion, Jump Diffusion

Suggested Citation

Pun, Chi Seng and Chung, Shing Fung and Wong, Hoi Ying, Variance Swap with Mean Reversion, Multifactor Stochastic Volatility and Jumps (March 28, 2015). European Journal of Operational Research. 245, 571-580, Available at SSRN: https://ssrn.com/abstract=3613752

Chi Seng Pun (Contact Author)

Nanyang Technological University (NTU) - School of Physical and Mathematical Sciences ( email )

SPMS-MAS-05-22
21 Nanyang Link
Singapore, 637371
Singapore
(+65) 6513 7468 (Phone)

HOME PAGE: http://personal.ntu.edu.sg/cspun/

Shing Fung Chung

The Chinese University of Hong Kong (CUHK) - Department of Statistics ( email )

Room 139, Lady Shaw Building
Shatin, 250
Hong Kong

Hoi Ying Wong

The Chinese University of Hong Kong (CUHK) - Department of Statistics ( email )

Shatin, N.T.
Hong Kong

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