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Pricing variance and volatility swaps in a stochastic volatility model with regime switching: discrete observations case

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  • Robert J. Elliott
  • Guang-Hua Lian

Abstract

This study presents a set of closed-form exact solutions for pricing discretely sampled variance swaps and volatility swaps, based on the Heston stochastic volatility model with regime switching. In comparison with all the previous studies in the literature, this research, which obtains closed-form exact solutions for variance and volatility swaps with discrete sampling times, serves several purposes. (1) It verifies the degree of validity of Elliott et al. 's [ Appl. Math. Finance , 2007, 14 (1), 41--62] continuous-sampling-time approximation for variance and volatility swaps of relatively short sampling periods. (2) It examines the effect of ignoring regime switching on pricing variance and volatility swaps. (3) It contributes to bridging the gap between Zhu and Lian's [ Math. Finance , 2011, 21 (2), 233--256] approach and Elliott et al. 's framework. (4) Finally, it presents a semi-Monte-Carlo simulation for the pricing of other important realized variance based derivatives.

Suggested Citation

  • Robert J. Elliott & Guang-Hua Lian, 2012. "Pricing variance and volatility swaps in a stochastic volatility model with regime switching: discrete observations case," Quantitative Finance, Taylor & Francis Journals, vol. 13(5), pages 687-698, March.
    • Handle: RePEc:taf:quantf:v:13:y:2012:i:5:p:687-698
    DOI: 10.1080/14697688.2012.676208
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    Cited by:

    1. Jin, Xing & Hong, Yi, 2023. "Jump-diffusion volatility models for variance swaps: An empirical performance analysis," International Review of Financial Analysis, Elsevier, vol. 87(C).
    2. Cao, Jiling & Lian, Guanghua & Roslan, Teh Raihana Nazirah, 2016. "Pricing variance swaps under stochastic volatility and stochastic interest rate," Applied Mathematics and Computation, Elsevier, vol. 277(C), pages 72-81.
    3. Weiyi Liu & Song‐Ping Zhu, 2019. "Pricing variance swaps under the Hawkes jump‐diffusion process," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(6), pages 635-655, June.

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