Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/25135
Authors: 
Detlefsen, Kai
Härdle, Wolfgang Karl
Year of Publication: 
2006
Series/Report no.: 
SFB 649 discussion paper 2006-052
Abstract: 
Recently, Diebold and Li (2003) obtained good forecasting results for yield curves in a reparametrized Nelson-Siegel framework. We analyze similar modeling approaches for price curves of variance swaps that serve nowadays as hedging instruments for options on realized variance. We consider the popular Heston model, reparametrize its variance swap price formula and model the entire variance swap curves by two exponential factors whose loadings evolve dynamically on a weekly basis. Generalizing this approach we consider a reparametrization of the three-dimensional Nelson-Siegel factor model. We show that these factors can be interpreted as level, slope and curvature and how they can be estimated directly from characteristic points of the curves. Moreover, we analyze a semiparametric factor model. Estimating autoregressive models for the factor loadings we get termstructure forecasts that we compare in addition to the random walk and the static Heston model that is often used in industry. In contrast to the results of Diebold and Li (2003) on yield curves, no model produces better forecasts of variance swap curves than the random walk but forecasting the Heston model improves the popular static Heston model. Moreover, the Heston model is better than the flexible semiparametric approach that outperforms the Nelson-Siegel model.
Subjects: 
Term structure
Variance swap curve
Heston model
Nelson- Siegel curve
Semiparametric factor model
JEL: 
G1
D4
C5
Document Type: 
Working Paper

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