Managing Forward Volatility and Skew Risk
12 Pages Posted: 16 Feb 2021 Last revised: 7 Apr 2021
Date Written: February 10, 2021
The forward start dual volatility swap is introduced. It can be regarded as the analog for volatility of what the entropy contract is for variance. Under the risk neutral measure it is shown that the difference between the forward start volatility swap and its dual is approximately the difference between two specific forward start implied volatilities. A dynamic replicating strategy is given which enables practitioners to approximately but robustly hedge forward start (dual) volatility swaps and the forward start skew using no more than two forward start options.
Keywords: implied volatility, skew, volatility swaps, stochastic volatility
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