PRICING VOLATILITY SWAP USING HESTON STOCHASTIC VOLATILITY MODEL

In this paper, we price the volatility swap as an OTC derivatives aimed for direct trading of volatility. Our pricing method is based on a PDE approach on Heston stochastic volatility model. Heston model has received the most attention since it can give a satisfactory description of the underlying asset dynamics. We follow the PDE approach suggested by Broadie and Jain (2008) to price volatility swap. In addition to their work, we alsoUse loss function minimization to calibrate the Heston parameters to the current data on S&P 500 index and construct implied volatility surface.Solve the PDE using numerical computation, Crank-Nicolson finite difference method.Price the volatility swap and compare our model expected volatility (fair volatility strike) with the realized volatility, in order to assess the accuracy of this approach.Our result shows that the model fair volatility strike is close to the realized volatility for long maturity swaps.