Local Volatility of Volatility for the VIX Market
27 Pages Posted: 11 Dec 2011 Last revised: 9 Oct 2013
Date Written: December 10, 2011
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: Suggested Citation