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Quadratic variance swap models

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  • Filipović, Damir
  • Gourier, Elise
  • Mancini, Loriano

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

  • Filipović, Damir & Gourier, Elise & Mancini, Loriano, 2016. "Quadratic variance swap models," Journal of Financial Economics, Elsevier, vol. 119(1), pages 44-68.
    • Handle: RePEc:eee:jfinec:v:119:y:2016:i:1:p:44-68
    DOI: 10.1016/j.jfineco.2015.08.015
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    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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