Article by: Peter Larkin
Published by: Kellogg College, University of Oxford
Date: 18 Apr 2012
“Over the last years, there has been a growing interest in pricing and hedging financial products contingent on the volatility or variance of tradable assets. In parallel to this, there is a fundamental need to price in such a way as to capture all the information available in the market – in particular, in the observed implied volatility smile.
“The volatility of an equity is the simplest measure of how risky it is, or perhaps how much it is likely to move around in the future, based on how it has moved historically, or what the market implies it to be in the future. Investors may wish to trade volatility if they believe they have some insight into the level of future volatility. For example, if a trader thinks that volatility is currently too low, he or she may want to take a position which allows them to profit if volatility increases.
“In this work we are interested in a one important part of this growing area – the pricing and hedging or European options whose pay-off at maturity depends on the quadratic variation of the underlying process.”
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