Pricing Variance Swaps Under Stochastic Volatility and Stochastic Interest Rate
Author | : Jiling Cao |
Publisher | : |
Total Pages | : 16 |
Release | : 2014 |
Genre | : |
ISBN | : |
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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 is applied which later reduces to solving sets of one-dimensional partial differential equation. A close form exact solution to the fair delivery price of a variance swap is obtained via derivation of characteristic functions. Practical implementation of this hybrid model is demonstrated through numerical simulations.