Modeling and Pricing of Variance and Volatility Swaps for Local Semi-Markov Volatilities in Financial Engineering

Anatoliy Swishchuk and Raimondo Manca

Mathematical Problems in Engineering, 2010, vol. 2010, 1-17

Abstract:

We consider a semi-Markov modulated security market consisting of a riskless asset or bond with constant interest rate and risky asset or stock, whose dynamics follow gemoetric Brownian motion with volatility that depends on semi-Markov process. Two cases for semi-Markov volatilities are studied: local current and local semi-Markov volatilities. Using the martingale characterization of semi-Markov processes, we find the minimal martingale measure for this incomplete market. Then we model and price variance and volatility swaps for local semi-Markov stochastic volatilities.

Date: 2010
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Persistent link: https://EconPapers.repec.org/RePEc:hin:jnlmpe:537571

DOI: 10.1155/2010/537571

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