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Valuation of VIX derivatives

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  • Mencía, Javier
  • Sentana, Enrique

Abstract

We conduct an extensive empirical analysis of VIX derivative valuation models before, during, and after the 2008–2009 financial crisis. Since the restrictive mean-reversion and heteroskedasticity features of existing models yield large distortions during the crisis, we propose generalisations with a time-varying central tendency, jumps, and stochastic volatility, analyse their pricing performance, and implications for term structures of VIX futures and volatility “skews.” We find that a process for the log of the observed VIX combining central tendency and stochastic volatility reliably prices VIX derivatives. We also uncover a significant risk premium that shifts the long-run volatility level.

Suggested Citation

  • Mencía, Javier & Sentana, Enrique, 2013. "Valuation of VIX derivatives," Journal of Financial Economics, Elsevier, vol. 108(2), pages 367-391.
  • Handle: RePEc:eee:jfinec:v:108:y:2013:i:2:p:367-391
    DOI: 10.1016/j.jfineco.2012.12.003
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    Citations

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    Cited by:

    1. Bu, Ruijun & Jawadi, Fredj & Li, Yuyi, 2017. "An empirical comparison of transformed diffusion models for VIX and VIX futures," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 116-127.
    2. repec:eee:eneeco:v:68:y:2017:i:c:p:53-65 is not listed on IDEAS
    3. KALNINA, Ilze & XIU, Dacheng, 2015. "Nonparametric estimation of the leverage effect: a trade-off between robustness and efficiency," Cahiers de recherche 2015-05, Universite de Montreal, Departement de sciences economiques.
    4. Jiao Li, 2016. "Trading VIX futures under mean reversion with regime switching," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(03), pages 1-20, September.
    5. Song, Zhaogang & Xiu, Dacheng, 2016. "A tale of two option markets: Pricing kernels and volatility risk," Journal of Econometrics, Elsevier, vol. 190(1), pages 176-196.
    6. repec:ids:ijbder:v:3:y:2017:i:2:p:153-175 is not listed on IDEAS
    7. Mencía, Javier & Sentana, Enrique, 2015. "Volatility-related exchange traded assets: an econometric investigation," CEPR Discussion Papers 10444, C.E.P.R. Discussion Papers.
    8. Tim Leung & Jiao Li & Xin Li & Zheng Wang, 2016. "Speculative Futures Trading under Mean Reversion," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(4), pages 281-304, December.
    9. Lian, Guanghua & Chiarella, Carl & Kalev, Petko S., 2014. "Volatility swaps and volatility options on discretely sampled realized variance," Journal of Economic Dynamics and Control, Elsevier, vol. 47(C), pages 239-262.
    10. Andrea Barletta & Paolo Santucci de Magistris & Francesco Violante, 2016. "Retrieving Risk-Neutral Densities Embedded in VIX Options: a Non-Structural Approach," CREATES Research Papers 2016-20, Department of Economics and Business Economics, Aarhus University.
    11. Stéphane Goutte & Amine Ismail & Huyên Pham, 2017. "Regime-switching Stochastic Volatility Model : Estimation and Calibration to VIX options," Working Papers hal-01212018, HAL.
    12. Tim Leung & Brian Ward, 2017. "Dynamic Index Tracking and Risk Exposure Control Using Derivatives," Papers 1705.10454, arXiv.org.
    13. Andrea Barletta & Paolo Santucci de Magistris & Francesco Violante, 0404. "A Non-Structural Investigation of VIX Risk Neutral Density," CREATES Research Papers 2017-15, Department of Economics and Business Economics, Aarhus University.
    14. Gonzalez-Perez, Maria T., 2015. "Model-free volatility indexes in the financial literature: A review," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 141-159.
    15. Li, Jing & Li, Lingfei & Zhang, Gongqiu, 2017. "Pure jump models for pricing and hedging VIX derivatives," Journal of Economic Dynamics and Control, Elsevier, vol. 74(C), pages 28-55.
    16. Jiao Li, 2016. "Trading VIX Futures under Mean Reversion with Regime Switching," Papers 1605.07945, arXiv.org, revised Jun 2016.
    17. Park, Yang-Ho, 2016. "The effects of asymmetric volatility and jumps on the pricing of VIX derivatives," Journal of Econometrics, Elsevier, vol. 192(1), pages 313-328.

    More about this item

    Keywords

    Central tendency; Stochastic volatility; Jumps; Term structure; Volatility skews;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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