Neutral and indifference pricing with stochastic correlation and volatility

Abstract

In this paper, we consider a Wishart Affine Stochastic Correlation (WASC) model which accounts for the stochastic volatilities of the assets and for the stochastic correlations not only between the underlying assets' returns but also between their volatilities. Under the assumptions of the model, we derive the neutral and indifference pricing for general European-style financial contracts. The paper shows that comparing to risk-neutral pricing, the utility-based pricing methods are generally feasible and avoid factitiously dealing with some risk premia corresponding to the volatilities-correlations as a consequence of the incompleteness of the market.