Pricing of Variance, Volatility, Covariance, and Correlation Swaps
Variance, volatility, covariance, and correlation swaps are relatively recent financial products that market participants can use for volatility hedging and speculation. The market for these types of swaps has been growing, with many investment banks and other financial institutions now actively quoting volatility swaps on various assets: stock indexes, currencies, and commodities.
A stock’s volatility is the simplest measure of its riskiness or uncertainty. In this entry we describe, model, and price variance, volatility, covariance, and correlation swaps.
DESCRIPTION OF SWAPS
We begin with a description of the different kinds of swaps that we will be discussing in this entry: variance swaps, volatility swaps, covariance swaps, and correlation swaps. Table 1 provides a summary of studies dealing with these swaps.