Pricing Variance Swaps in a Hybrid Model of Stochastic Volatility and Interest Rate With Regime-switching

Date
2016-03-28
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Item type
Commissioned Report
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arXiv
Abstract

In this paper, we consider the problem of pricing discretely-sampled variance swaps based on a hybrid model of stochastic volatility and stochastic interest rate with regime-switching. Our modeling framework extends the Heston stochastic volatility model by including the CIR stochastic interest rate and model parameters that switch according to a continuous-time observable Markov chain process. A semi-closed form pricing formula for variance swaps is derived. The pricing formula is assessed through numerical implementations, and the impact of including regime-switching on pricing variance swaps is also discussed.

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Keywords
Heston-CIR hybrid model; Regime-switching; Realized variance; Stochastic interest rate; Stochastic volatility; Variance swap
Source
arXiv:1603.08289 [q-fin.MF]
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