Volatility swaps valuation under a modified risk-neutralized Heston model with a stochastic long-run variance level

Xin-Jiang He; Sha Lin

doi:10.21914/anziamj.v64.17204

Authors

Xin-Jiang He Zhejiang University of Technology https://orcid.org/0000-0003-1429-5463
Sha Lin Zhejiang Gongshang University https://orcid.org/0000-0003-1692-8711

DOI:

https://doi.org/10.21914/anziamj.v64.17204

Keywords:

volatility swaps, modified Heston model, risk-neutralized volatility, stochastic long-run variance, analytical solution

Abstract

We consider the pricing of discretely sampled volatility swaps under a modified Heston model, whose risk-neutralized volatility process contains a stochastic long-run variance level. We derive an analytical forward characteristic function under this model, which has never been presented in the literature before. Based on this, we further obtain an analytical pricing formula for volatility swaps which can guarantee the computational accuracy and efficiency. We also demonstrate the significant impact of the introduced stochastic long-run variance level on volatility swap prices with synthetic as well as calibrated parameters.

doi: 10.1017/S144618112200013X

Author Biographies

Xin-Jiang He, Zhejiang University of Technology

School of Economics, Zhejiang University of Technology, Hangzhou, China.

Sha Lin, Zhejiang Gongshang University

School of Finance, Zhejiang Gongshang University, Hangzhou, China.