Pricing Power Options Under Hybrid Stochastic and Local Volatility

Abstract

Power options are derivatives whose payoffs involve a powerof the underlying asset price. They are important instruments with broadpotential applications in financial markets, including equity-indexed annuities. However, much of the existing literature assumes constant volatility,which tends to deviate from real financial market behavior. To addressthis limitation, we price power options under a hybrid volatility structurethat combines local and stochastic volatility