The Effect of Jumps and Discrete Sampling on Volatility and Variance Swaps

International Journal of Theoretical and Applied Finance, Vol. 11, No. 8, pp. 761-797, 2008

Posted: 2 Dec 2009

See all articles by Mark Broadie

Mark Broadie

Columbia University - Columbia Business School - Decision Risk and Operations

Ashish Jain

Columbia University - Columbia Business School

Abstract

We investigate the effect of discrete sampling and asset price jumps on fair variance and volatility swap strikes. Fair discrete volatility strikes and fair discrete variance strikes are derived in different models of the underlying evolution of the asset price: the Black-Scholes model, the Heston stochastic volatility model, the Merton jump-diffusion model and the Bates and Scott stochastic volatility and jump model. We determine fair discrete and continuous variance strikes analytically and fair discrete and continuous volatility strikes using simulation and variance reduction techniques and numerical integration techniques in all models. Numerical results show that the well-known convexity correction formula may not provide a good approximation of fair volatility strikes in models with jumps in the underlying asset. For realistic contract specifications and model parameters, we find that the effect of discrete sampling is typically small while the effect of jumps can be significant.

Keywords: Variance swaps, volatility swaps, VIX, stochastic volatility, jump models

Suggested Citation

Broadie, Mark and Jain, Ashish, The Effect of Jumps and Discrete Sampling on Volatility and Variance Swaps. International Journal of Theoretical and Applied Finance, Vol. 11, No. 8, pp. 761-797, 2008, Available at SSRN: https://ssrn.com/abstract=1516247

Mark Broadie (Contact Author)

Columbia University - Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States
212-854-4103 (Phone)

Ashish Jain

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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