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Quadratic Variance Swap Models

Author

Listed:
  • Damir Filipović

    (Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute)

  • Elise Gourier

    (ESSEC Business School)

  • Loriano Mancini

    (USI Lugano - Institute of Finance; Swiss Finance Institute)

Abstract

We introduce a novel class of term structure models for variance swaps. The multivariate state process is characterized by a quadratic diffusion function. The variance swap curve is quadratic in the state variable and available in closed form, greatly facilitating empirical analysis. Various goodness-of-fit tests show that quadratic models fit variance swaps on the S&P 500 remarkably well, and outperform affine models. We solve a dynamic optimal portfolio problem in variance swaps, index option, stock index and bond. An empirical analysis uncovers robust features of the optimal investment strategy.

Suggested Citation

  • Damir Filipović & Elise Gourier & Loriano Mancini, 2013. "Quadratic Variance Swap Models," Swiss Finance Institute Research Paper Series 13-06, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1306
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    File URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2237512
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    Cited by:

    1. Dew-Becker, Ian & Giglio, Stefano & Le, Anh & Rodriguez, Marius, 2017. "The price of variance risk," Journal of Financial Economics, Elsevier, vol. 123(2), pages 225-250.

    More about this item

    Keywords

    stochastic volatility; variance swap; quadratic term structure; quadratic jump-diffusion; dynamic optimal portfolio;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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