Exotic option, stochastic volatility and incentive scheme

摘要

This paper examines the impact of incentive fee on exotic option pricing when the volatility is a stochastic process and is correlated with the underlying asset price. Since high water mark (HWM) is the benchmark employed by incentive schemes in the hedge fund industry, we first develop the HWM lookback option-pricing framework in stochastic volatility model. This provides an improvement to previous works in constant volatility model. We also explore option prices through Monte Carlo (MC) simulation and variance reduction technique. We further demonstrate that our discrete simulation to HWM option pricing is more practical than models assuming continuous collection of incentive fees. Numerical examples illustrate how the stochastic volatility models and incentive scheme influence option pricing.