Model-independent hedging strategies for variance swaps

DOI10.1007/S00780-012-0190-3zbMATH Open1262.91134arXiv1104.4010OpenAlexW2152245377MaRDI QIDQ693029FDOQ693029

Authors: Martin Klimmek, David Hobson 

Publication date: 7 December 2012

Published in: Finance and Stochastics (Search for Journal in Brave)

Abstract: A variance swap is a derivative with a path-dependent payoff which allows investors to take positions on the future variability of an asset. In the idealised setting of a continuously monitored variance swap written on an asset with continuous paths it is well known that the variance swap payoff can be replicated exactly using a portfolio of puts and calls and a dynamic position in the asset. This fact forms the basis of the VIX contract. But what if we are in the more realistic setting where the contract is based on discrete monitoring, and the underlying asset may have jumps? We show that it is possible to derive model-independent, no-arbitrage bounds on the price of the variance swap, and corresponding sub- and super-replicating strategies. Further, we characterise the optimal bounds. The form of the hedges depends crucially on the kernel used to define the variance swap.

Full work available at URL: https://arxiv.org/abs/1104.4010

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zbMATH Keywords

jumpsvariance swapsSkorokhod embeddinghedging strategiesmodel-independent boundsno-arbitrage prices

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Stopping times; optimal stopping problems; gambling theory (60G40)

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Cited In (51)

• Model-independent bounds for option prices -- a mass transport approach
• A trajectorial interpretation of Doob's martingale inequalities
• Maximizing functionals of the maximum in the Skorokhod embedding problem and an application to variance swaps
• Fine properties of the optimal Skorokhod embedding problem
• It only takes a few moments to hedge options
• Martingale optimal transport and robust hedging in continuous time
• Consistent variance curve models
• Hedging European derivatives with the polynomial variance swap under uncertain volatility environments
• Pathwise versions of the Burkholder-Davis-Gundy inequality
• Weighted variance swaps hedge against impermanent loss
• The space of outcomes of semi-static trading strategies need not be closed
• Pricing variance swaps on time-changed Markov processes
• THE VARIANCE SWAP CONTRACT UNDER THE CEV PROCESS
• Model uncertainty, recalibration, and the emergence of delta-vega hedging
• Short Communication: A Primer on Perpetuals
• Robust replication of volatility and hybrid derivatives on jump diffusions
• An explicit martingale version of the one-dimensional Brenier theorem
• A general property for time aggregation
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• Quadratic variation, models, applications and lessons
• A model-free version of the fundamental theorem of asset pricing and the super-replication theorem
• Tightening robust price bounds for exotic derivatives
• Arbitrage bounds for prices of weighted variance swaps
• Robust price bounds for the forward starting straddle
• MULTIVARIATE DISTRIBUTIONS FOR FINANCIAL RETURNS
• Hedging variance options on continuous semimartingales
• Pathwise superreplication via Vovk's outer measure
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