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Closed-form variance swap prices under general affine GARCH models and their continuous-time limits

Author

Listed:
  • Alexandru Badescu

    (University of Calgary)

  • Zhenyu Cui

    (Stevens Institute of Technology)

  • Juan-Pablo Ortega

    (Universität Sankt Gallen
    Université de Franche-Comté)

Abstract

Fully explicit closed-form expressions are developed for the fair strike prices of discrete-time variance swaps under general affine GARCH type models that have been risk-neutralized with a family of variance dependent pricing kernels. The methodology relies on solving differential recursions for the coefficients of the joint cumulant generating function of the log price and the conditional variance processes. An alternative derivation is provided in the case of Gaussian innovations. Using standard assumptions on the asymptotic behavior of the GARCH parameters as the sampling frequency increases, the diffusion limit of a Gaussian GARCH model is derived and the convergence of the variance swap prices to its continuous-time limit is further investigated. Numerical examples on the term structure of the variance swap rates and on the convergence results are also presented.

Suggested Citation

  • Alexandru Badescu & Zhenyu Cui & Juan-Pablo Ortega, 2019. "Closed-form variance swap prices under general affine GARCH models and their continuous-time limits," Annals of Operations Research, Springer, vol. 282(1), pages 27-57, November.
    • Handle: RePEc:spr:annopr:v:282:y:2019:i:1:d:10.1007_s10479-018-2941-9
    DOI: 10.1007/s10479-018-2941-9
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    References listed on IDEAS

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    Cited by:

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    2. Escobar-Anel, Marcos & Gollart, Maximilian & Zagst, Rudi, 2022. "Closed-form portfolio optimization under GARCH models," Operations Research Perspectives, Elsevier, vol. 9(C).
    3. Lazar, Emese & Qi, Shuyuan, 2022. "Model risk in the over-the-counter market," European Journal of Operational Research, Elsevier, vol. 298(2), pages 769-784.
    4. Escobar-Anel, Marcos & Rastegari, Javad & Stentoft, Lars, 2021. "Option pricing with conditional GARCH models," European Journal of Operational Research, Elsevier, vol. 289(1), pages 350-363.
    5. He, Xin-Jiang & Lin, Sha, 2023. "Analytically pricing variance and volatility swaps under a Markov-modulated model with liquidity risks," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    6. Escobar-Anel, Marcos & Rastegari, Javad & Stentoft, Lars, 2020. "Affine multivariate GARCH models," Journal of Banking & Finance, Elsevier, vol. 118(C).
    7. Xu, De-xuan & Yang, Ben-zhang & Kang, Jian-hao & Huang, Nan-jing, 2021. "Variance and volatility swaps valuations with the stochastic liquidity risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 566(C).
    8. Hongkai Cao & Alexandru Badescu & Zhenyu Cui & Sarath Kumar Jayaraman, 2020. "Valuation of VIX and target volatility options with affine GARCH models," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(12), pages 1880-1917, December.
    9. Maciej Augustyniak & Alexandru Badescu, 2021. "On the computation of hedging strategies in affine GARCH models," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(5), pages 710-735, May.

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