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The Term Structure of Variance Swap Rates and Optimal Variance Swap Investments

Published online by Cambridge University Press:  12 August 2010

Daniel Egloff ,
Markus Leippold  and
Liuren Wu
Daniel Egloff
Affiliation:
QuantCatalyst, Hardturmstrasse 101, 8005 Zurich, Switzerland. daniel.egloff@quantcatalyst.com.
Markus Leippold
Affiliation:
University of Zurich, Swiss Banking Institute, Plattenstrasse 14, 8032 Zurich, Switzerland. leippold@isb.uzh.ch.
Liuren Wu
Affiliation:
Baruch College, Zicklin School of Business, One Bernard Baruch Way, Box B10-225, New York, NY 10010. liuren.wu@baruch.cuny.edu.
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Abstract

This paper performs specification analysis on the term structure of variance swap rates on the S&P 500 index and studies the optimal investment decision on the variance swaps and the stock index. The analysis identifies 2 stochastic variance risk factors, which govern the short and long end of the variance swap term structure variation, respectively. The highly negative estimate for the market price of variance risk makes it optimal for an investor to take short positions in a short-term variance swap contract, long positions in a long-term variance swap contract, and short positions in the stock index.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 5 , October 2010 , pp. 1279 - 1310
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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