Discounted-likelihood valuation of variance and volatility swaps
Abstract The valuation of financial derivatives often assumes risk neutrality with respect to the risk-neutral martingale measure, which prevents arbitrage opportunities. However, casual traders may still incur substantial losses when trading at this risk-neutral price, especially when the price has...
Saved in:
| Main Authors: | , , |
|---|---|
| Format: | Article |
| Language: | English |
| Published: |
SpringerOpen
2025-01-01
|
| Series: | Financial Innovation |
| Subjects: | |
| Online Access: | https://doi.org/10.1186/s40854-024-00701-8 |
| Tags: |
Add Tag
No Tags, Be the first to tag this record!
|
| _version_ | 1841544384693141504 |
|---|---|
| author | Napat Rujeerapaiboon Sanae Rujivan Hongdan Chen |
| author_facet | Napat Rujeerapaiboon Sanae Rujivan Hongdan Chen |
| author_sort | Napat Rujeerapaiboon |
| collection | DOAJ |
| description | Abstract The valuation of financial derivatives often assumes risk neutrality with respect to the risk-neutral martingale measure, which prevents arbitrage opportunities. However, casual traders may still incur substantial losses when trading at this risk-neutral price, especially when the price has to be paid now and the payoff is only realized in the future. This study proposes a new valuation framework that provides risk-sensitive investors with an additional safeguard. The proposed framework embraces a worst-case perspective while exploiting the underlier’s stochastic process, representing a combination of robust optimization and stochastic programming. Notably, it aims to mitigate losses in the likelier scenarios of the underlying asset’s prices. When the underlier’s returns are independent and lognormally but not necessarily identically distributed, our approach for pricing variance and volatility swaps could be greatly simplified, benefit from parallel computing, and be solved by a two-dimensional grid search. We further derive a closed-form solution in some special stationary cases and provide experimental results to highlight the effect of risk aversion on fending off sizable trading losses. |
| format | Article |
| id | doaj-art-c242216e3751405e8b389bccb62a413b |
| institution | Kabale University |
| issn | 2199-4730 |
| language | English |
| publishDate | 2025-01-01 |
| publisher | SpringerOpen |
| record_format | Article |
| series | Financial Innovation |
| spelling | doaj-art-c242216e3751405e8b389bccb62a413b2025-01-12T12:36:14ZengSpringerOpenFinancial Innovation2199-47302025-01-0111113410.1186/s40854-024-00701-8Discounted-likelihood valuation of variance and volatility swapsNapat Rujeerapaiboon0Sanae Rujivan1Hongdan Chen2Department of Industrial Systems Engineering and Management, National University of SingaporeCenter of Excellence in Data Science for Health Study, School of Science, Walailak UniversityDepartment of Industrial Systems Engineering and Management, National University of SingaporeAbstract The valuation of financial derivatives often assumes risk neutrality with respect to the risk-neutral martingale measure, which prevents arbitrage opportunities. However, casual traders may still incur substantial losses when trading at this risk-neutral price, especially when the price has to be paid now and the payoff is only realized in the future. This study proposes a new valuation framework that provides risk-sensitive investors with an additional safeguard. The proposed framework embraces a worst-case perspective while exploiting the underlier’s stochastic process, representing a combination of robust optimization and stochastic programming. Notably, it aims to mitigate losses in the likelier scenarios of the underlying asset’s prices. When the underlier’s returns are independent and lognormally but not necessarily identically distributed, our approach for pricing variance and volatility swaps could be greatly simplified, benefit from parallel computing, and be solved by a two-dimensional grid search. We further derive a closed-form solution in some special stationary cases and provide experimental results to highlight the effect of risk aversion on fending off sizable trading losses.https://doi.org/10.1186/s40854-024-00701-8Variance swapsVolatility swapsDerivative pricingRobust optimizationRisk aversion |
| spellingShingle | Napat Rujeerapaiboon Sanae Rujivan Hongdan Chen Discounted-likelihood valuation of variance and volatility swaps Financial Innovation Variance swaps Volatility swaps Derivative pricing Robust optimization Risk aversion |
| title | Discounted-likelihood valuation of variance and volatility swaps |
| title_full | Discounted-likelihood valuation of variance and volatility swaps |
| title_fullStr | Discounted-likelihood valuation of variance and volatility swaps |
| title_full_unstemmed | Discounted-likelihood valuation of variance and volatility swaps |
| title_short | Discounted-likelihood valuation of variance and volatility swaps |
| title_sort | discounted likelihood valuation of variance and volatility swaps |
| topic | Variance swaps Volatility swaps Derivative pricing Robust optimization Risk aversion |
| url | https://doi.org/10.1186/s40854-024-00701-8 |
| work_keys_str_mv | AT napatrujeerapaiboon discountedlikelihoodvaluationofvarianceandvolatilityswaps AT sanaerujivan discountedlikelihoodvaluationofvarianceandvolatilityswaps AT hongdanchen discountedlikelihoodvaluationofvarianceandvolatilityswaps |