Model-Free Discretisation-Invariant Swap Contracts
Abstract
Realised pay-offs for discretisation-invariant swaps are those which satisfy a restricted `aggregation property' of Neuberger [2012] for twice continuously differentiable deterministic functions of a multivariate martingale. They are initially characterised as solutions to a second-order system of PDEs, then those pay-offs based on martingale and log-martingale processes alone form a vector space. Hence there exist an infinite variety of other variance and higher-moment risk premia that are less prone to bias than standard variance swaps because their option replication portfolios have no discrete-monitoring or jump errors. Their fair values are also independent of the monitoring partition. A sub-class consists of pay-offs with fair values that are further free from numerical integration errors over option strikes. Here exact pricing and hedging is possible via dynamic trading strategies on a few vanilla puts and calls. An S&P 500 empirical study on higher-moment and other DI swaps concludes.
Keywords
Cite
@article{arxiv.1602.00235,
title = {Model-Free Discretisation-Invariant Swap Contracts},
author = {Carol Alexander and Johannes Rauch},
journal= {arXiv preprint arXiv:1602.00235},
year = {2016}
}