- Theoretical exact hedging recipe: Var swap can be hedged using a log contract, which itself can be replicated with a continuum of OTM calls and puts, this result is model independent; Vol swap hedging is model dependent.
- Risk: From a sellers' perspective, Var swap has higher risk because convexity means the payoff can be very huge in extreme volatility spike events; Vol swap is relatively "safer".
- Hedging in practice: Vol swap is easier to hedge in practice than Var swap. First, the payoff of Vol swap is monotonic in S (<=> less convexity); Second, under high volatility scenario, hedging a Var swap requires many options to be hedged, but usually under these circumstances the option market is not liquid enough.
Hi,
ReplyDeleteDo you know any rule of thumb that relates the price of a variance swap with a volatility swap?
I am trying to get an approximation for the volatility swap price from variance swap prices but don't want to fit an stochastic volatility or jump difussion model. Maybe you know a way to calculate the convexity adjustment easily?
Thanks
I recall reading a paper few years back:
Deletehttp://math.cims.nyu.edu/financial_mathematics/content/02_financial/2008-3.pdf
I don't remember if there is any 'rule of thumb' though. Perhaps it's a good excuse to revise volatility derivatives ;) Come back to this blog in a few weeks.