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

69 Pages Posted: 4 Jun 2016 Last revised: 2 Feb 2017

See all articles by Chris Bardgett

Chris Bardgett

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

Elise Gourier

ESSEC Business School

Markus Leippold

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

Date Written: November 17, 2016

Abstract

This paper shows that the VIX market contains information that is not already contained by the S&P 500 market on the variance of the S&P 500 returns. 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, our premium has better predictive power than the usual model-free estimate and the higher-order moments of its term structure allow improving forecasts of S&P 500 returns.

Keywords: S&P 500 and VIX joint modeling, volatility dynamics, particle filter, variance risk premium

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 (November 17, 2016). Paris December 2016 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2787161 or http://dx.doi.org/10.2139/ssrn.2787161

Chris BARDGETT

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

Schönberggasse 1
Zürich, 8001
Switzerland

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 (Contact Author)

ESSEC Business School ( email )

3 avenue Bernard Hirsch
Cergy-Pontoise, 95021
France

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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