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Short communication: inversion of convex ordering: local volatility does not maximise the price of VIX futures

Author

Listed:
  • Acciaio, Beatrice
  • Guyon, Julien

Abstract

It has often been stated that, within the class of continuous stochastic volatility models calibrated to vanillas, the price of a VIX future is maximized by the Dupire local volatility model. In this article we prove that this statement is incorrect: we build a continuous stochastic volatility model in which a VIX future is strictly more expensive than in its associated local volatility model. More generally, in our model, strictly convex payoffs on a squared VIX are strictly cheaper than in the associated local volatility model. This corresponds to an inversion of convex ordering between local and stochastic variances, when moving from instantaneous variances to squared VIX, as convex payoffs on instantaneous variances are always cheaper in the local volatility model. We thus prove that this inversion of convex ordering, which is observed in the S&P 500 market for short VIX maturities, can be produced by a continuous stochastic volatility model. We also prove that the model can be extended so that, as suggested by market data, the convex ordering is preserved for long maturities.

Suggested Citation

  • Acciaio, Beatrice & Guyon, Julien, 2020. "Short communication: inversion of convex ordering: local volatility does not maximise the price of VIX futures," LSE Research Online Documents on Economics 102984, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:102984
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    File URL: http://eprints.lse.ac.uk/102984/
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    References listed on IDEAS

    as
    1. Daniel Lacker & Mykhaylo Shkolnikov & Jiacheng Zhang, 2019. "Inverting the Markovian projection, with an application to local stochastic volatility models," Papers 1905.06213, arXiv.org.
    2. Mathias Beiglboeck & Peter Friz & Stephan Sturm, 2010. "Is the minimum value of an option on variance generated by local volatility?," Papers 1001.4031, arXiv.org, revised Jan 2011.
    3. Frédéric Abergel & Rémi Tachet, 2010. "A nonlinear partial integro-differential equation from mathematical finance," Post-Print hal-00611962, HAL.
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    Citations

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    Cited by:

    1. Mathias Beiglbock & Gudmund Pammer & Walter Schachermayer, 2021. "From Bachelier to Dupire via Optimal Transport," Papers 2106.12395, arXiv.org.
    2. Mathias Beiglböck & Gudmund Pammer & Walter Schachermayer, 2022. "From Bachelier to Dupire via optimal transport," Finance and Stochastics, Springer, vol. 26(1), pages 59-84, January.
    3. Jim Gatheral & Paul Jusselin & Mathieu Rosenbaum, 2020. "The quadratic rough Heston model and the joint S&P 500/VIX smile calibration problem," Papers 2001.01789, arXiv.org.

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    More about this item

    Keywords

    VIX; VIX futures; stochastic volatility; local volatility; convex order; inversion of convex ordering;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General

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