Option pricing and hedging under a stochastic volatility Lévy process model

Young Shin Kim, Frank J. Fabozzi, Zuodong Lin, Svetlozar T. Rachev

Research output: Contribution to journalArticle

7 Scopus citations

Abstract

In this paper, we discuss a stochastic volatility model with a Lévy driving process and then apply the model to option pricing and hedging. The stochastic volatility in our model is defined by the continuous Markov chain. The risk-neutral measure is obtained by applying the Esscher transform. The option price using this model is computed by the Fourier transform method. We obtain the closed-form solution for the hedge ratio by applying locally risk-minimizing hedging.

Original languageEnglish
Pages (from-to)81-97
Number of pages17
JournalReview of Derivatives Research
Volume15
Issue number1
DOIs
StatePublished - Apr 2012

Keywords

  • Continuous Markov chain
  • Esscher transform
  • Hedging
  • Lévy process
  • Option pricing
  • Regime-switching model
  • Stochastic volatility

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