Variance and volatility swaps in energy markets

Anatoliy Swishchuk

Abstract

ABSTRACT

This paper focuses on the pricing of variance and volatility swaps in the energy market. An explicit variance swap formula and a closed-form volatility swap formula (using the Brockhaus-Long approximation) for energy assets with stochastic volatility are found. These formulas follow the continuous-time generalized autoregressive conditional heteroskedasticity (1,1) (GARCH(1,1)) model (meanreverting) or the Pilipovic one-factor model. A numerical example is presented for the AECO natural gas index.