Simple Variance Swaps

Abstract

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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