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

• Format: Others
• Published: arXiv, 2016-09-19T04:41:21Z.
• Subjects: Heston-CIR hybrid model; Regime-switching; Realized variance; Stochastic interest rate; Stochastic volatility; Variance swap; Commissioned Report
• Online Access: Get fulltext

 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.