On the pricing of forward starting options in Heston’s model on stochastic volatility

Susanne Kruse () and Ulrich Nögel ()

Finance and Stochastics, 2005, vol. 9, issue 2, 233-250

Abstract: We consider the problem of pricing European forward starting options in the presence of stochastic volatility. By performing a change of measure using the asset price at the time of strike determination as a numeraire, we derive a closed-form solution within Heston’s stochastic volatility framework applying distribution properties of the volatility process. In this paper we develop a new and more suitable formula for pricing forward starting options. This formula allows to cover the smile effects observed in a Black-Scholes environment, in which the extreme exposure of forward starting options to volatility changes is ignored. Copyright Springer-Verlag Berlin/Heidelberg 2005

Keywords: Forward starting options; Heston’s model; stochastic volatility; cliquet options; option pricing; Girsanov’s theorem (search for similar items in EconPapers)
Date: 2005
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Citations: View citations in EconPapers (20)

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DOI: 10.1007/s00780-004-0146-3

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