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Variance And Volatility Swaps Under A Two-Factor Stochastic Volatility Model With Regime Switching

Author

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  • XIN-JIANG HE

    (School of Mathematics and Applied Statistics, University of Wollongong, Wollongong, NSW 2522, Australia)

  • SONG-PING ZHU

    (School of Mathematics and Applied Statistics, University of Wollongong, Wollongong, NSW 2522, Australia)

Abstract

In this paper, the pricing problem of variance and volatility swaps is discussed under a two-factor stochastic volatility model. This model can be treated as a two-factor Heston model with one factor following the CIR process and another characterized by a Markov chain, with the motivation originating from the popularity of the Heston model and the strong evidence of the existence of regime switching in real markets. Based on the derived forward characteristic function of the underlying price, analytical pricing formulae for variance and volatility swaps are presented, and numerical experiments are also conducted to compare swap prices calculated through our formulae and those obtained under the Heston model to show whether the introduction of the regime switching factor would lead to any significant difference.

Suggested Citation

  • Xin-Jiang He & Song-Ping Zhu, 2019. "Variance And Volatility Swaps Under A Two-Factor Stochastic Volatility Model With Regime Switching," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-19, June.
    • Handle: RePEc:wsi:ijtafx:v:22:y:2019:i:04:n:s0219024919500092
    DOI: 10.1142/S0219024919500092
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    References listed on IDEAS

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    Cited by:

    1. Sha Lin & Xin-Jiang He, 2022. "Analytically Pricing European Options under a New Two-Factor Heston Model with Regime Switching," Computational Economics, Springer;Society for Computational Economics, vol. 59(3), pages 1069-1085, March.
    2. 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).

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