Valuation of Volatility Derivatives as an Inverse Problem

Ground-breaking recent work by Carr and Lee extends well-known results for variance swaps to arbitrary functions of realized variance, provided a zero-correlation assumption is made. We give a detailed mathematical analysis of some of their computations and work out the cases of volatility swaps and calls on variance. The latter leads to an ill-posed problem that we solve using regularization techniques. The sum is divergent, that means we can do something. -Heaviside