An aversion to variance

As volatility spiked in late 2008, variance swaps contributed to huge bank losses, particularly in single stocks. Some dealers have now stopped quoting single-stock variance swaps, while activity in the broader market has been scaled back. Mark Pengelly reports

Variance swaps have proven tricky beasts to risk manage. These instruments grant investors a payout equal to the difference between realised variance and a pre-agreed strike level, times the vega notional. But because variance is the square of volatility, an unpredictable trading environment can have dramatic effects on variance positions. As a consequence, bad bets on variance have led to significant losses for users in the past. Towards the end of 2008, they struck once again. After September