Variance Swap Portfolio Theory

13 Pages Posted: 28 Jan 2010 Last revised: 3 May 2010

See all articles by Dilip B. Madan

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

Date Written: November 8, 2009

Abstract

Optimal portfolios of variance swaps are constructed taking account of both autocorrelation and cross asset dependencies. Market prices of variance swaps are extracted from option surface calibrations. The methods developed permit simulation of cash flows to arbitrary portfolios of variance swaps. The optimal design maximizes the index of acceptability introduced in Cherny and Madan (2009). Full nonlinear optimization is contrasted with Simultaneous Perturbation Stochastic Approximation (SPSA). Preliminary out of sample results favor the use of SPSA.

Keywords: SPSA, Concave Distortion, Correlated Levy Processes

JEL Classification: G1, G12, G13

Suggested Citation

Madan, Dilip B., Variance Swap Portfolio Theory (November 8, 2009). Robert H. Smith School Research Paper No. RHS 06-114. Available at SSRN: https://ssrn.com/abstract=1540815 or http://dx.doi.org/10.2139/ssrn.1540815

Dilip B. Madan (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)

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