Pricing vulnerable reset options under stochastic volatility jump diffusion model using 3-D FFT

Libin Wang and Lixia Liu

Communications in Statistics - Theory and Methods, 2025, vol. 54, issue 15, 4791-4818

Abstract: Under the comprehensive model of assets which satisfy the triple conditions of stochastic jump, stochastic volatility, and stochastic interest rate, the pricing problem of reset options with default risk is investigated. First, two-dimensional log-normal distribution and radical process with reverting property are applied to describe sudden jump of assets and time-varying characteristics of volatility and interest rate, respectively. Further, through the principle of risk neutral pricing with the characteristic function method, we establish the joint characteristic function related to the options. Second, according to measure transform and payoff function decomposition, the analytical pricing and hedging share formulas of vulnerable reset options are given. Third, 3-D fast Fourier transform is constructed to obtain a fast and asymptotic solution of option prices. Finally, the accuracy and stability of 3-D fast Fourier transform is analyzed through numerical examples. The experimental results show that the proposed method can solve the complex pricing problem of vulnerable reset options more efficiently.

Date: 2025
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DOI: 10.1080/03610926.2024.2427233

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