Valuation of Vix Derivatives

Abstract:     
We conduct an extensive empirical analysis of VIX derivative valuation models before, during and after the 2008-2009 financial 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 signicant risk premium that shifts the long run volatility level.

Number of Pages in PDF File: 59

Keywords: Central Tendency, Stochastic Volatility, Jumps, Term Structure, Volatility Skews

JEL Classification: G13

working papers series