Sato Processes and the Valuation of Structured Products
41 Pages Posted: 15 Jan 2007
Date Written: July 3, 2007
Abstract
We report on the adequacy of using Sato processes to value equity structured products. An analysis of the variance of realized variance for Sato processes shows that these processes may be suited to option contracts on realized volatility. Nonlinear pricing principles based on hedging to acceptability are outlined for the purpose of pricing structured transactions. It is shown that typically different products should be priced using different models. Pricing comparisons of Sato process prices with other standard models like Heston stochastic volatility, with and without jumps, VGSA, local volatility and local CGMY are also provided. Sato processes tend to overprice cliquets relative to other models. They also maintain the value of long dated out-of-the-money realized variance options.
Keywords: Options on Realized Variance, Forward Starts, Ziggurat for Levy Processes
JEL Classification: G10, G12, G13
Suggested Citation: Suggested Citation
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