Pricing Volatility Swaps Under Heston's Stochastic Volatility Model with Regime Switching

Robert Elliott, Tak Kuen Siu and Leunglung Chan

Applied Mathematical Finance, 2007, vol. 14, issue 1, 41-62

Abstract: A model is developed for pricing volatility derivatives, such as variance swaps and volatility swaps under a continuous-time Markov-modulated version of the stochastic volatility (SV) model developed by Heston. In particular, it is supposed that the parameters of this version of Heston's SV model depend on the states of a continuous-time observable Markov chain process, which can be interpreted as the states of an observable macroeconomic factor. The market considered is incomplete in general, and hence, there is more than one equivalent martingale pricing measure. The regime switching Esscher transform used by Elliott et al. is adopted to determine a martingale pricing measure for the valuation of variance and volatility swaps in this incomplete market. Both probabilistic and partial differential equation (PDE) approaches are considered for the valuation of volatility derivatives.

Keywords: Regime switching Esscher transform; Markov-modulated Heston's SV model; observable Markov chain process; volatility swaps; variance swaps; regime switching OU-process (search for similar items in EconPapers)
Date: 2007
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (54)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/13504860600659222 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:apmtfi:v:14:y:2007:i:1:p:41-62

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RAMF20

DOI: 10.1080/13504860600659222

Access Statistics for this article

Applied Mathematical Finance is currently edited by Professor Ben Hambly and Christoph Reisinger

More articles in Applied Mathematical Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().