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Pricing variance swaps under stochastic volatility and stochastic interest rate

Cao, Jiling and Lian, Guanghua and Roslan, Teh Raihana Nazirah (2016) Pricing variance swaps under stochastic volatility and stochastic interest rate. Applied Mathematics and Computation, 277. pp. 72-81. ISSN 0096-3003

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In this paper, we investigate the effects of imposing stochastic interest rate driven by the Cox–Ingersoll–Ross process along with the Heston stochastic volatility model for pricing variance swaps with discrete sampling times. A dimension reduction mechanism based on the framework of Little and Pant (2001) is applied which later reduces to solving two three-dimensional partial differential equations. A semi-closed form solution to the fair delivery price of a variance swap is obtained via the derivation of characteristic functions. Practical implementation of this hybrid model is demonstrated through numerical simulations.

Item Type: Article
Uncontrolled Keywords: Generalized Fourier transform; Heston–CIR hybrid model; Realized variance; Stochastic interest rate; Stochastic volatility; Variance swap
Subjects: Q Science > QA Mathematics > QA75 Electronic computers. Computer science
Divisions: School of Quantitative Sciences
Depositing User: Mdm. Teh Raihana Nazirah Roslan
Date Deposited: 28 Jun 2016 03:15
Last Modified: 28 Jun 2016 03:15
URI: http://repo.uum.edu.my/id/eprint/18314

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