Discretely sampled variance and volatility swaps versus their continuous approximations
AbstractDiscretely sampled variance and volatility swaps trade actively in OTC markets. To price these swaps, the continuously sampled approximation is often used to simplify the computations. The purpose of this paper is to study the conditions under which this approximation is valid. Our first set of theorems characterize the conditions under which the discretely sampled swap values are finite, given that the values of the continuous approximations exist. Surprisingly, for some otherwise reasonable price processes, the discretely sampled swap prices do not exist, thereby invalidating the approximation. Examples are provided. Assuming further that both swap values exist, we study sufficient conditions under which the discretely sampled values converge to their continuous counterparts. Because of its popularity in the literature, we apply our theorems to the 3/2 stochastic volatility model. Although we can show finiteness of all swap values, we can prove convergence of the approximation only for some parameter values. Copyright Springer-Verlag 2013
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Bibliographic InfoArticle provided by Springer in its journal Finance and Stochastics.
Volume (Year): 17 (2013)
Issue (Month): 2 (April)
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Web page: http://www.springerlink.com/content/101164/
Find related papers by JEL classification:
- 60G - - - - - -
- 60G - - - - - -
- C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
- C69 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Other
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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- Peter Carr & Jian Sun, 2007. "A new approach for option pricing under stochastic volatility," Review of Derivatives Research, Springer, vol. 10(2), pages 87-150, May.
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- Carol Alexander & Johannes Rauch, 2014. "Discretisation-Invariant Swaps," Papers 1404.1351, arXiv.org.
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