Abstract

This paper further investigates a novel derivative called dispersion swap, which was first introduced in Dhaene et al. (2024), within a multi-asset continuous-time financial market. Similar to correlation and covariance swaps, dispersion swaps can trade correlation risk in the financial market. In this continuous-time market, we consider a stochastic correlation among assets and show that the set of equivalent risk-neutral measures can be characterized by the market price of risk for the stochastic correlation. We derive the general condition of market completeness and show how to price the dispersion swap within the continuous-time market framework. Utilizing the Vasicek model and the Jacobi bounded process to model instantaneous stochastic correlation respectively, we present numerical results for pricing dispersion swaps and demonstrate that dispersion swaps can be a useful tool to hedge the correlation risk in the financial market.