Pricing of mountain range derivatives under a principal component stochastic volatility model

Abstract

In this paper, a multidimensional stochastic volatility process is introduced. This process is simpler than existing ones in terms of number of parameters while keeping practical stylized facts like stochastic correlation and volatility. The pricing of two mountain range derivatives, Altavista and Everest, is analyzed under this framework, showing sensitivities to parameters, number of eigenvalues, and maturity time. Copyright © 2012 John Wiley & Sons, Ltd.