The objective of this advanced-level course is to give you a good understanding of state-of-the-art approaches to modelling, pricing, forecasting and trading volatility and correlation.
We start with a general introduction to volatility and correlation, explaining concepts such as realized volatility, implied volatility, stochastic volatility etc., and we discuss their importance for pricing and risk measurement.
Thereafter, we look into how volatility is modelled and forecasted. With real-life market data, we demonstrate how day-to-day and intraday volatility is calculated, and we explain and how these estimates can be smoothed and extrapolated to future time periods using moving averages, exponential moving averages, spline models, and ARMA and GARCH modelling.
We then present and discuss a number of instruments and strategies for volatility trading. These include traditional volatility trading strategies in options, but we also look "variance swaps" and other newer types of instruments. To help us determine current volatility levels relative to historical volatility, we introduce the concept of "volatility cones", and we show how traders can use this – and other – techniques identify potentially profitable trading opportunities.
Further, we explain how the same instruments and forecasting techniques can be used to hedge portfolios of options and other instruments that are exposed to volatility risk.
We then turn to look at correlation. We present various models for estimating correlation, and we discuss possible problems related to the stability (or lack of stability) of correlation amongst assets. We present and explain a number of strategies for trading correlation, including "dispersion trades", buying and selling correlation and using OTC covariance swaps.
Finally, we explain how correlation risk can be mitigated using various instruments and techniques.