5 Pages Posted: 20 Jul 2011
Date Written: July 14, 2006
The main goal of this thesis is to rationalize why dispersion trading is a worth-while strategy. Therefore, definitions of volatility and correlation are presented and their modeling and predictability are discussed extensively. In particular, we rigorously investigate different measures of average correlation of an index. Thereby, we set the foundations for academically discussing dispersion trading. Using the concept of average correlation we rationalize that the potential profit obtained in a dispersion trade can be attributed to particular properties of the index volatility skew and to a negative premium for correlation risk. We confirm these results and recent empirical findings by examining the average correlation of the Dow Jones Euro Stoxx 50.
Keywords: Volatility Trading, Dispersion Trading, Correlation Trading
JEL Classification: G10, G13
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