Pricing Options on Realized Variance
26 Pages Posted: 11 Mar 2005 Last revised: 30 Jan 2010
Date Written: January 26, 2005
Models which hypothesize that returns are pure jump processes with independent increments have been shown to be capable of capturing the observed variation of market prices of vanilla stock options across strike and maturity. In this paper, these models are employed to derive in closed form the prices of derivatives written on future realized quadratic variation. Alternative work on pricing derivatives on quadratic variation has alternatively assumed that the underlying returns process is continuous over time. We compare the model values of derivatives on quadratic variation for the two types of models and find substantial differences.
Keywords: Options on Variance Swaps, Options on Time Changes, Self Decomposability and its Hierarchy
JEL Classification: G10, G12, G13
Suggested Citation: Suggested Citation