Information derivatives

Andrei Soklakov considers the problem of creating derivatives to provide tailored exposure to volatility risk. Information theory leads us to a whole class of such products. This class of 'information derivatives' includes the standard volatility products (for example, variance and gamma swaps) as special cases, which suggests the use of liquidity models as a basis for further refinement of standard volatility derivatives

It has long been recognised that the concept of randomness is essential in describing the evolution of asset prices. Traditionally, the amount of randomness in the returns of financial assets is measured by their volatility. Until recently, volatility was used merely as a descriptive concept - an important theoretical characterisation of a tradable asset. The situation has changed with the arrival of volatility derivatives such as variance and gamma swaps that treat volatility as a tradable