Abstract.
We consider the problem of pricing European forward starting options in the presence of stochastic volatility. By performing a change of measure using the asset price at the time of strike determination as a numeraire, we derive a closed-form solution within Heston’s stochastic volatility framework applying distribution properties of the volatility process. In this paper we develop a new and more suitable formula for pricing forward starting options. This formula allows to cover the smile effects observed in a Black-Scholes environment, in which the extreme exposure of forward starting options to volatility changes is ignored.
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Received: July 2004,
Mathematics Subject Classification (2000):
91B28, 60G44, 60H30, 60E10
JEL Classification:
G13
It is a pleasure to thank the anonymous referee for his valuable comments and suggestions on this paper. Furthermore, we would like to thank Holger Kraft, University of Kaiserslautern, and Alexander Giese, HypoVereinsbank AG Munich, for fruitful discussions and suggestions.
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Kruse, S., Nögel, U. On the pricing of forward starting options in Heston’s model on stochastic volatility. Finance Stochast. 9, 233–250 (2005). https://doi.org/10.1007/s00780-004-0146-3
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DOI: https://doi.org/10.1007/s00780-004-0146-3