Valuation of forward start options under affine jump-diffusion models

João Pedro Vidal Nunes and Tiago Ramalho Viegas Alcaria

Quantitative Finance, 2016, vol. 16, issue 5, 727-747

Abstract: Under the general affine jump-diffusion framework of Duffie et al. [ Econometrica , 2000, 68 , 1343--1376], this paper proposes an alternative pricing methodology for European-style forward start options that does not require any parallel optimization routine to ensure square integrability. Therefore, the proposed methodology is shown to possess a better accuracy--efficiency trade-off than the usual and more general approach initiated by Hong [Forward Smile and Derivative Pricing. Working paper, UBS, 2004] that is based on the knowledge of the forward characteristic function . Explicit pricing solutions are also offered under the nested jump-diffusion setting proposed by Bakshi et al. [ J. Finance , 1997, 52 , 2003--2049], which accommodates stochastic volatility and stochastic interest rates, and different integration schemes are numerically tested.

Date: 2016
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DOI: 10.1080/14697688.2015.1049200

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