Forecasting the Term Structure of Variance Swaps
AbstractRecently, Diebold and Li (2003) obtained good forecasting results for yield curves in a reparametrized Nelson-Siegel framework. We analyze similar modeling approaches for price curves of variance swaps that serve nowadays as hedging instruments for options on realized variance. We consider the popular Heston model, reparametrize its variance swap price formula and model the entire variance swap curves by two exponential factors whose loadings evolve dynamically on a weekly basis. Generalizing this approach we consider a reparametrization of the three-dimensional Nelson-Siegel factor model. We show that these factors can be interpreted as level, slope and curvature and how they can be estimated directly from characteristic points of the curves. Moreover, we analyze a semiparametric factor model. Estimating autoregressive models for the factor loadings we get termstructure forecasts that we compare in addition to the random walk and the static Heston model that is often used in industry. In contrast to the results of Diebold and Li (2003) on yield curves, no model produces better forecasts of variance swap curves than the random walk but forecasting the Heston model improves the popular static Heston model. Moreover, the Heston model is better than the flexible semiparametric approach that outperforms the Nelson-Siegel model.
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Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-052.
Length: 32 pages
Date of creation: Jul 2006
Date of revision:
Term structure; Variance swap curve; Heston model; Nelson-Siegel curve; Semiparametric factor model;
Find related papers by JEL classification:
- G1 - Financial Economics - - General Financial Markets
- D4 - Microeconomics - - Market Structure and Pricing
- C5 - Mathematical and Quantitative Methods - - Econometric Modeling
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-07-15 (All new papers)
- NEP-ECM-2006-07-15 (Econometrics)
- NEP-ETS-2006-07-15 (Econometric Time Series)
- NEP-FIN-2006-07-15 (Finance)
- NEP-FMK-2006-07-15 (Financial Markets)
- NEP-FOR-2006-07-15 (Forecasting)
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