Pricing variance swaps by using two methods: replication strategy and a stochastic volatility model

Abstract: In this paper we investigate pricing of variance swaps contracts. Theliterature is mostly dedicated to the pricing using replication withportfolio of vanilla options. In some papers the valuation with stochasticvolatility models is discussed as well. Stochastic volatility is becomingmore and more interesting to the investors. Therefore we decided toperform valuation with the Heston stochastic volatility model, as wellas by using replication strategy.The thesis was done at SunGard Front Arena, so for testing the replica-tion strategy Front Arena software was used. For calibration and testingof the Heston model we used MatLab.