THESIS
2022
1 online resource (ix, 50 pages) : illustrations (some color)
Abstract
Quantitative Investment Models deal with investment in stock and bond and generally
leave derivative securities aside. These Investment models argue that since derivatives
can be replicated using stock and bonds they help us span no risk factors which we can’t
other wise span using stocks and bonds only. This make derivative securities redundant.
In this Thesis we argue otherwise and provide evidence for the existence or risk factors
other than the ones which stock and bond span. We start with examining the jump risk
and variance risk premiums, and then using elegant stochastic optimal control based
models explain the theoretical need for investment in derivatives. Here we find from a
theoretical point of view that investment in derivatives saves investors from bankruptcy
risk and risk...[
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Quantitative Investment Models deal with investment in stock and bond and generally
leave derivative securities aside. These Investment models argue that since derivatives
can be replicated using stock and bonds they help us span no risk factors which we can’t
other wise span using stocks and bonds only. This make derivative securities redundant.
In this Thesis we argue otherwise and provide evidence for the existence or risk factors
other than the ones which stock and bond span. We start with examining the jump risk
and variance risk premiums, and then using elegant stochastic optimal control based
models explain the theoretical need for investment in derivatives. Here we find from a
theoretical point of view that investment in derivatives saves investors from bankruptcy
risk and risk of time varying stochastic volatility. This theoretical model is important as
many practitioners still do not invest in derivatives considering them to be redundant
securities.
We create Term Structure models for investment in variance swaps and show that a two
factor term structure model best fits our data set. The price of variance swap under a
general Affine term structure model is found and this for formula is valid for arbitrary
number of factors. With a better understanding of variance risk, we suggest the use of
both short term and long term variance swaps in portfolio management. In particular,
we find selling short term variance swaps and buying long term variance improves
provides a significant improvement in investment outcomes i.e sharp ratio etc.
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