Valuation of Vix Derivatives

59 Pages Posted: 20 Dec 2009 Last revised: 11 Sep 2012

Javier Mencia

Banco de España

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

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Date Written: July 22, 2012

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.

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

JEL Classification: G13

Suggested Citation

Mencia, Javier and Sentana, Enrique, Valuation of Vix Derivatives (July 22, 2012). Available at SSRN: https://ssrn.com/abstract=1524193 or http://dx.doi.org/10.2139/ssrn.1524193

Javier Mencia (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain
+34 91 338 5414 (Phone)
+34 91 338 6104 (Fax)

HOME PAGE: http://www.bde.es/investigador/staff/66.htm

Enrique Sentana

Financial Markets Group

Houghton Street
London School of Economics & Political Science (LSE)
London WC2A 2AE
United Kingdom
+44 20 7955 7002 (Phone)
+44 20 7852 3580 (Fax)

Centre for Economic Policy Research (CEPR)

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London, EC1V 3PZ
United Kingdom

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

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