Local Volatility of Volatility for the VIX Market

27 Pages Posted: 11 Dec 2011 Last revised: 9 Oct 2013

See all articles by Gabriel G. Drimus

Gabriel G. Drimus

Institute of Banking and Finance, University of Zürich

Walter Farkas

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; ETH Zürich

Date Written: December 10, 2011

Abstract

Following a trend of sustained and accelerated growth, the VIX futures and options market has become a closely followed, active and liquid market. The standard stochastic volatility models -- which focus on the modeling of instantaneous variance -- are unable to fit the entire term structure of VIX futures as well as the entire VIX options surface. In contrast, we propose to model directly the VIX index, in a mean-reverting local volatility-of-volatility model, which will provide a global fit to the VIX market. We then show how to construct the local volatility-of-volatility surface by adapting the ideas in Carr (2008) and Andreasen, Huge (2010) to a mean-reverting process.

Keywords: VIX futures, VIX options, volatility of volatility, volatility derivatives

JEL Classification: C63, G13

Suggested Citation

Drimus, Gabriel G. and Farkas, Walter, Local Volatility of Volatility for the VIX Market (December 10, 2011). Review of Derivatives Research, 16(3), 267-293, (2013). Available at SSRN: https://ssrn.com/abstract=1970547 or http://dx.doi.org/10.2139/ssrn.1970547

Gabriel G. Drimus (Contact Author)

Institute of Banking and Finance, University of Zürich ( email )

Plattenstrasse 14
Zürich, CH-8032
Switzerland

Walter Farkas

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland
+41-44-634 3953 (Phone)
+41-44-634 4345 (Fax)

HOME PAGE: http://https://people.math.ethz.ch/~farkas/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

ETH Zürich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
851
Abstract Views
4,572
rank
29,543
PlumX Metrics