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Pricing Volatility Referenced Assets

Author

Listed:
  • Alan De Genaro Dario

    (Bolsa de Mercadorias & Futuros (BM&F) e Instituto de Matemática e Estatística (IME/USP))

Abstract

Volatility swaps are contingent claims on future realized volatility. Variance swaps are similar instruments on future realized variance, the square of future realized volatility. Unlike a plain vanilla option, whose volatility exposure is contaminated by its asset price dependence, volatility and variance swaps provide a pure exposure to volatility alone. This article discusses the risk-neutral valuation of volatility and variance swaps based on the framework outlined in the Heston (1993) stochastic volatility model. Additionally, the Heston (1993) model is calibrated for foreign currency options traded at BMF and its parameters are used to price swaps on volatility and variance of the BRL / USD exchange rate.

Suggested Citation

  • Alan De Genaro Dario, 2006. "Pricing Volatility Referenced Assets," Brazilian Review of Finance, Brazilian Society of Finance, vol. 4(2), pages 203-228.
    • Handle: RePEc:brf:journl:v:4:y:2006:i:2:p:203-228
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    More about this item

    Keywords

    asset pricing; volatility swap; stochastic volatility; Heston model; model calibration;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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