Valuation of options on discretely sampled variance: a general analytic approximation

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.