Title: A Numerical Study of Carr and Lee's Correlation Immunization Strategy for Volatility Derivatives,
Abstract: In their seminal work `Robust Replication of Volatility Derivatives,' Carr
and Lee show how to robustly price and replicate a variety of claims written on
the quadratic variation of a risky asset under the assumption that the asset's
volatility process is independent of the Brownian motion that drives the
asset's price. Additionally, they propose a correlation immunization method
that minimizes the pricing and hedging error that results when the correlation
between the risky asset's price and volatility is nonzero. In this paper, we
perform a number of Monte Carlo experiments to test the effectiveness of Carr
and Lee's immunization strategy. Our results indicate that the correlation
immunization method is an effective means of reducing pricing and hedging
errors that result from nonzero correlation.