For the log-squared contract used for covariance swap replication in Section 8.5.1, use replication through calls and

Question:

For the log-squared contract used for covariance swap replication in Section 8.5.1, use replication through calls and puts to demonstrate that a negatively sloped implied correlation smile, linear in log(K/FB(T )

and calibrated to the vol at strike K = FB(T ) will always be more expensive than the flat correlation equivalent, to first order.

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer: