Price and Volatility Dynamics Implied by the VIX Term Structure

Abstract:     
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-specied 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, G13

working papers series