Advanced Search
MyIDEAS: Login

Swap Rate Variance Swaps

Contents:

Author Info

  • Nicolas Merener
Registered author(s):

    Abstract

    We study the hedging and valuation of generalized variance swaps de¯ned on a forward swap interest rate. Our motivation is the fundamental role of variance swaps in the transfer of variance risk, and the extensive empirical evidence documenting that the variance realized by interest rates is stochastic. We identify a hedging rule involving a static European contract and the gains of a dynamic position on forward interest rate swaps. Two distinguishing features arise in the context of interest rates: the nonlinear and multidimensional relationship between the values of the dynamically traded contracts and the underlying swap rate, and the possible stochasticity of the interest rate at which gains are reinvested. The combination of these two features leads to additional terms in the cumulative dynamic trading gains, which depend on realized variance and are taken into consideration in the determination of the appropriate static hedge. We characterize the static payo® function as the solution of an ordinary di®erential equation, and derive explicitly the associated dynamic strategy. We use daily interest rate data between 1997 and 2007 to test the e®ectiveness of our hedging methodology in arithmetic and geometric variance swaps and verify that the hedging error is small compared to the bid-ask spread in swaption prices.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://www.utdt.edu/download.php?fname=_124700003437846200.pdf
    Download Restriction: no

    Bibliographic Info

    Paper provided by Universidad Torcuato Di Tella in its series Business School Working Papers with number 2009-02.

    as in new window
    Length: 43 pages
    Date of creation: Feb 2009
    Date of revision:
    Handle: RePEc:udt:wpbsdt:2009-02

    Contact details of provider:
    Postal: Miñones 2177 - (1428) Buenos Aires
    Web page: http://www.utdt.edu/listado_contenidos.php?id_item_menu=4994
    More information through EDIRC

    Related research

    Keywords:

    This paper has been announced in the following NEP Reports:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
    2. Claudio Albanese & Harry Lo & Aleksandar Mijatovi\'c, 2009. "Spectral methods for volatility derivatives," Papers 0905.2091, arXiv.org.
    3. Windcliff, H. & Forsyth, P.A. & Vetzal, K.R., 2006. "Pricing methods and hedging strategies for volatility derivatives," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 409-431, February.
    4. Peter Carr & Hélyette Geman & Dilip Madan & Marc Yor, 2005. "Pricing options on realized variance," Finance and Stochastics, Springer, vol. 9(4), pages 453-475, October.
    5. Sam Howison & Avraam Rafailidis & Henrik Rasmussen, 2004. "On the pricing and hedging of volatility derivatives," Applied Mathematical Finance, Taylor & Francis Journals, vol. 11(4), pages 317-346.
    6. Andersen, Torben G. & Lund, Jesper, 1997. "Estimating continuous-time stochastic volatility models of the short-term interest rate," Journal of Econometrics, Elsevier, vol. 77(2), pages 343-377, April.
    7. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-51, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:udt:wpbsdt:2009-02. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Nicolás Del Ponte).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.