Type: Seminar

Distribution: World

Expiry: 30 Mar 2012

Auth: uri@101.161.1.48 (ukeich) in SMS-WASM

David Hobson Department of Statistics University of Warwick, UK Location: Carslaw 273 Time: 2pm Friday, March 30, 2012 Title: Robust hedging of variance swaps Abstract: Consider the problem of pricing the floating leg of variance swap. Under the twin assumptions of continuous monitoring and a price process which is continuous, Dupire and Neuberger separately showed how the variance swap can be replicated perfectly with an investment in the underlying and the puchase of -2 (minus two) log contracts. The log contracts can be replicated with vanilla options so that if calls and puts are liquidly traded then the variance swap has a unique model independent price. But what if the price process is not continuous, or if, as is always the case in practice, the payoff of the variance swap is based on price changes over a finite number of dates? We show how to construct best possible sub- and super-hedges for the variance swaps, and describe the worst case models. A perhaps suprising corollary is that the effects of jumps depends crucially on the precise formulation of the kernel of the variance swap.