Quadratic variance swap models
Journal of Financial Economics · 2016 · Volume 119 · Issue 1
DOI: 10.1016/j.jfineco.2015.08.015
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.
Keywords
Quadratic jump-diffusion, Quadratic term structure, Dynamic optimal portfolio, Variance swap, Stochastic volatility
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