AN ANALYTICAL APPROACH FOR VARIANCE SWAPS WITH AN ORNSTEIN–UHLENBECK PROCESS. (19th July 2017)

• Record Type: Journal Article
• Authors: CAO, JIAN-PENG; FANG, YAN-BING
• Is Part Of: ANZIAM journal. Volume 59:Number 1(2017)
• Page Start: 83
• Page End: 102
• Publication Date: 2017-07-19
• Subjects: 91B70; variance swaps, -- Ornstein–Uhlenbeck process, -- closed-form solution, -- stochastic volatility; 510.5
• DOI: 10.1017/S1446181117000268
• Languages: English
• ISSNs: 1446-1811

Abstract

Abstract : Pricing variance swaps have become a popular subject recently, and most research of this type come under Heston's two-factor model. This paper is an extension of some recent research which used the dimension-reduction technique based on the Heston model. A new closed-form pricing formula focusing on a log-return variance swap is presented here, under the assumption that the underlying asset prices can be described by a mean-reverting Gaussian volatility model (Ornstein–Uhlenbeck process). Numerical tests in two respects using the Monte Carlo (MC) simulation are included. Moreover, we discuss a procedure of solving a quadratic differential equation with one variable. Our method can avoid the previously encountered limitations, but requires more time for calculation than other recent analytical discrete models.