Variance improved performance

Abstract

We propose a simple and e cient way of forecasting the term structure of swap rates and we demonstrate how an investor might bene t from (i) the variance swap as an asset; and (ii) from the implied information present on the swap rate. We show that the Nelson-Siegel model is enough to capture the dynamics of the swap rate term- structure and that the three factors may be interpreted as the level, slope and curvature of the curve. Further, we show that the expected change in the swap rate predicts the one-month forward market return with an OOS R2 of 2.9%. An investment strategy in both the variance swap and the underlying yields out-of-sample annualized Sharpe ratios around 1.89 which are robust across several di erent portfolios.

Date of Award	14 Feb 2013
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	José Faias (Supervisor)