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On the pricing of forward starting options in Heston’s model on stochastic volatility

  • Susanne Kruse

    ()

  • Ulrich Nögel

    ()

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    We consider the problem of pricing European forward starting options in the presence of stochastic volatility. By performing a change of measure using the asset price at the time of strike determination as a numeraire, we derive a closed-form solution within Heston’s stochastic volatility framework applying distribution properties of the volatility process. In this paper we develop a new and more suitable formula for pricing forward starting options. This formula allows to cover the smile effects observed in a Black-Scholes environment, in which the extreme exposure of forward starting options to volatility changes is ignored. Copyright Springer-Verlag Berlin/Heidelberg 2005

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    File URL: http://hdl.handle.net/10.1007/s00780-004-0146-3
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    Article provided by Springer in its journal Finance and Stochastics.

    Volume (Year): 9 (2005)
    Issue (Month): 2 (04)
    Pages: 233-250

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    Handle: RePEc:spr:finsto:v:9:y:2005:i:2:p:233-250
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