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Pricing Bermudan Variance Swaptions Using Multinomial Trees

Honglei Zhao, Rupak Chatterjee, Thomas Lonon and Ionuţ Florescu
The Journal of Derivatives Spring 2019, 26 (3) 22-34; DOI: https://doi.org/10.3905/jod.2019.26.3.022
Honglei Zhao
is a PhD graduate in financial engineering at Stevens Institute of Technology in Hoboken, NJ
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Rupak Chatterjee
is a professor of physics at Stevens Institute of Technology in Hoboken, NJ
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Thomas Lonon
is an assistant teaching professor in Financial Engineering at Stevens Institute of Technology in Hoboken, NJ
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Ionuţ Florescu
is a research associate professor and director of Hanlon Laboratories at Stevens Institute of Technology in Hoboken, NJ
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Abstract

In a recent study, Zhao et al. (2017) presented a tree methodology to evaluate the expected generalized realized variance in a general stochastic volatility model; it provided an efficient way of calculating the fair value of the strike for variance swaps. In this article, the authors expand the methodology to price nonlinear derivatives written on realized variance. They introduce a new option contract, a Bermudan variance swaption, defined as an option on variance swap with early exercise dates. Within the same framework they also show how to value forward-start variance swaps, VIX futures, and VIX options. Numerical tests show that the methodology is efficient and accurate.

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The Journal of Derivatives: 26 (3)
The Journal of Derivatives
Vol. 26, Issue 3
Spring 2019
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Pricing Bermudan Variance Swaptions Using Multinomial Trees
Honglei Zhao, Rupak Chatterjee, Thomas Lonon, Ionuţ Florescu
The Journal of Derivatives Feb 2019, 26 (3) 22-34; DOI: 10.3905/jod.2019.26.3.022

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Pricing Bermudan Variance Swaptions Using Multinomial Trees
Honglei Zhao, Rupak Chatterjee, Thomas Lonon, Ionuţ Florescu
The Journal of Derivatives Feb 2019, 26 (3) 22-34; DOI: 10.3905/jod.2019.26.3.022
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  • Article
    • Abstract
    • FINANCIAL PRODUCTS
    • BERMUDAN VARIANCE SWAPTIONS
    • CONTRIBUTION OF OUR WORK
    • TREE PRICING METHODOLOGY
    • EUROPEAN DERIVATIVES PRICING
    • BERMUDAN VARIANCE SWAPTION PRICING
    • A SIMPLE FORMULA FOR FORWARD-START SWAPS
    • NUMERICAL EXPERIMENTS
    • CONCLUSION
    • REFERENCES
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