How widely used are variance swaps in institutional portfolios?
The variance swap market has grown steadily in recent years with institutional investors increasingly using variance swaps for hedging purposes or for portfolio diversification. For example, life assurance companies now offer many products with guaranteed benefits (e.g. variable annuities, with-profits funds) and these expose them to short volatility positions that may be offset by using variance swaps. Estimating total traded volumes is problematic, as with any OTC market, but recent estimates for daily traded volumes on indices are in the region of $3-5 million vega notional (source: Risk Magazine).This represents a 5- to 10-fold increase, compared to volumes three years ago. We estimate that around 20% of volatility exposure traded in the market is now done using variance swaps.
