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Inferring Volatility Dynamics and Risk Premia from the S&P 500 and VIX Markets

75 Pages Posted: 26 Jul 2013 Last revised: 22 Dec 2016

Chris Bardgett

University of Zurich - Department of Banking and Finance; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Elise Gourier

Queen Mary, University of London

Markus Leippold

University of Zurich - Department of Banking and Finance; University of Zurich - Faculty of Economics, Business Administration and Information Technology

Multiple version iconThere are 2 versions of this paper

Date Written: December 2016

Abstract

This paper shows that the VIX market contains information on the variance of the S&P 500 returns, which is not already spanned by the S&P 500 market. We estimate a flexible affine model based on a joint time series of underlying indexes and option prices on both markets. We find that including VIX option prices in the model estimation allows better identification of the parameters driving the risk-neutral conditional distributions and term structure of volatility, thereby enhancing the estimation of the variance risk premium. We gain new insights on the properties of the premium's term structure and show how they can be used to form trading signals. Finally, we show that our premium, used together with a measure of its term structure, has better predictive power on S&P 500 returns compared to the usual model-free premium.

Keywords: S&P 500 and VIX joint modeling, option pricing, particle

JEL Classification: G12, G13, C58.

Suggested Citation

Bardgett, Chris and Gourier, Elise and Leippold, Markus, Inferring Volatility Dynamics and Risk Premia from the S&P 500 and VIX Markets (December 2016). Swiss Finance Institute Research Paper No. 13-40. Available at SSRN: https://ssrn.com/abstract=2296826 or http://dx.doi.org/10.2139/ssrn.2296826

Chris BARDGETT (Contact Author)

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

Schönberggasse 1
Zürich, 8001
Switzerland

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

HOME PAGE: http://www.swissfinanceinstitute.ch/

Elise Gourier

Queen Mary, University of London ( email )

Mile End Road
London, E1 4NS
United Kingdom

HOME PAGE: http://www.elisegourier.com

Markus Leippold

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

Plattenstrasse 14
Zürich, 8032
Switzerland

University of Zurich - Faculty of Economics, Business Administration and Information Technology ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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