Target volatility option pricing in the lognormal fractional SABR model

Elisa Alòs, Rupak Chatterjee, Sebastian F. Tudor and Tai-Ho Wang

Quantitative Finance, 2019, vol. 19, issue 8, 1339-1356

Abstract: We examine in this article the pricing of target volatility options in the lognormal fractional SABR model. A decomposition formula of Itô's calculus yields an approximation formula for the price of a target volatility option in small time by the technique of freezing the coefficient. A decomposition formula in terms of Malliavin derivatives is also provided. Alternatively, we also derive closed form expressions for a small volatility of volatility expansion of the price of a target volatility option. Numerical experiments show the accuracy of the approximations over a reasonably wide range of parameters.

Date: 2019
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DOI: 10.1080/14697688.2019.1574021

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