Price and Volatility Dynamics Implied by the VIX Term Structure
National University of Singapore (NUS) - Business School and Risk Management Institute
National Chung Hsing University
June 7, 2011
A particle-lter based estimation method is developed for the stochastic volatility model with/without jumps and applied on the S&P 500 index value and the VIX term structure jointly. The model encompasses all mean-reverting stochastic volatility option pricing models with a constant elasticity of variance, and can allow for price jumps. Our contention is that using the VIX term structure in estimation can help us reach a more reliable conclusion in terms of the nature of the risk-neutral volatility dynamic. Our empirical ndings are: (1) the volatility process under the risk-neutral measure is mean-reverting; (2) the jump intensity is time-varying; (3) the jump and volatility risks are priced; (4) the measurement errors in VIXs are material; and (5) the square-root volatility process is grossly mis-specied with or without price jumps.
Number of Pages in PDF File: 40
Keywords: Model-free volatility, stochastic volatility, jumps, options, VIX term structure, Constant elasticity of variance
JEL Classification: G12, G13working papers series
Date posted: March 20, 2011 ; Last revised: March 16, 2012
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