NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Simple Variance Swaps

Ian Martin

NBER Working Paper No. 16884
Issued in March 2011
NBER Program(s):   AP

The large asset price jumps that took place during 2008 and 2009 disrupted volatility derivatives markets and caused the single-name variance swap market to dry up completely. This paper defines and analyzes a simple variance swap, a relative of the variance swap that in several respects has more desirable properties. First, simple variance swaps are robust: they can be easily priced and hedged even if prices can jump. Second, simple variance swaps supply a more accurate measure of market-implied variance than do variance swaps or the VIX index. Third, simple variance swaps provide a better way to measure and to trade correlation. The paper also explains how to interpret VIX in the presence of jumps.

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Document Object Identifier (DOI): 10.3386/w16884

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