Modeling and Pricing of Covariance and Correlation Swaps for Financial Markets with Semi-Markov Volatilities

TL;DR

This paper develops a semi-Markov volatility model for financial markets, deriving closed-form prices for volatility, covariance, and correlation swaps, with numerical evaluations demonstrating its practical application.

Contribution

It introduces a novel semi-Markov volatility framework and provides closed-form pricing formulas for covariance and correlation swaps in markets with two risky assets.

Findings

Closed-form pricing formulas for volatility, covariance, and correlation swaps.

Numerical evaluations illustrating the model's application.

Enhanced understanding of swap pricing in semi-Markov market models.

Abstract

In this paper, we model financial markets with semi-Markov volatilities and price covarinace and correlation swaps for this markets. Numerical evaluations of vari- nace, volatility, covarinace and correlations swaps with semi-Markov volatility are presented as well. The novelty of the paper lies in pricing of volatility swaps in closed form, and pricing of covariance and correlation swaps in a market with two risky assets.