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Target volatility option pricing in lognormal fractional SABR model

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  • Elisa Alos
  • Rupak Chatterjee
  • Sebastian Tudor
  • Tai-Ho Wang

Abstract

We examine in this article the pricing of target volatility options in the lognormal fractional SABR model. A decomposition formula by Ito's calculus yields a theoretical replicating strategy for the target volatility option, assuming the accessibilities of all variance swaps and swaptions. The same formula also suggests an approximation formula for the price of target volatility option in small time by the technique of freezing the coefficient. Alternatively, we also derive closed formed expressions for a small volatility of volatility expansion of the price of target volatility option. Numerical experiments show accuracy of the approximations in a reasonably wide range of parameters.

Suggested Citation

  • Elisa Alos & Rupak Chatterjee & Sebastian Tudor & Tai-Ho Wang, 2018. "Target volatility option pricing in lognormal fractional SABR model," Papers 1801.08215, arXiv.org.
    • Handle: RePEc:arx:papers:1801.08215
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    References listed on IDEAS

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    6. Jiro Akahori & Xiaoming Song & Tai-Ho Wang, 2017. "Probability density of lognormal fractional SABR model," Papers 1702.08081, arXiv.org, revised Jan 2019.
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