Arithmetic variance swaps

Leontsinis, Stamatis and Alexander, Carol (2016) Arithmetic variance swaps. Quantitative Finance, 17 (4). pp. 551-569. ISSN 1469-7688

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Abstract

Biases in standard variance swap rates can induce substantial deviations below market rates. Defining realised variance as the sum of squared price (not log-price) changes yields an `arithmetic' variance swap with no such biases. Its fair value has advantages over the standard variance swap rate: no discrete-monitoring or jump biases; and the same value applies for any monitoring frequency, even irregular monitoring and to any underlying, including those taking zero or negative values. We derive the fair-value for the arithmetic variance swap and compare with the standard variance swap rate by: analysing errors introduced by interpolation and integration techniques; numerical experiments for approximation accuracy; and using 23 years of FTSE 100 options data to explore the empirical properties of arithmetic variance (and higher-moment) swaps. The FTSE 100 variance risk has a strong negative correlation with the implied third moment, which can be captured using a higher-moment arithmetic swap.

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences
Depositing User: Joy Blake
Date Deposited: 09 Aug 2016 13:37
Last Modified: 11 May 2017 09:29
URI: http://sro.sussex.ac.uk/id/eprint/62303

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