Target volatility option pricing in the lognormal fractional SABR model

Abstract

We examine in this article the pricing of target volatility options in the lognormal fractional SABR model. A decomposition formula of Itô's calculus yields an approximation formula for the price of a target volatility option in small time by the technique of freezing the coefficient. A decomposition formula in terms of Malliavin derivatives is also provided. Alternatively, we also derive closed form expressions for a small volatility of volatility expansion of the price of a target volatility option. Numerical experiments show the accuracy of the approximations over a reasonably wide range of parameters.