A Dimension-invariant Cascade Model for VIX Futures

21 Pages Posted: 14 May 2019

See all articles by Zhiguang Wang

Zhiguang Wang

South Dakota State University

Brice V. Dupoyet

Florida International University - College of Business Administration - Finance

Date Written: December 19, 2019

Abstract

We propose a new model of volatility by allowing for a cascading structure of volatility components. The cascading feature is achieved by introducing an increasing structure to the speed of mean reversion. It allows us to add as many components as desired with no additional parameter, effectively defeating the curse of dimensionality often seen in traditional models. The flexibility in choosing the number of components enables rich dynamics in the term structure of both spot VIX and VIX futures, without the need to introduce price jumps. We derive a semi-closed form solution to the VIX futures price, and find that our 6-factor model with only 6 parameters can closely fit spot VIX and VIX futures data from 2004 to 2015 and produce out of sample pricing errors of magnitudes similar to those of in-sample errors.

JEL Classification: G13

Suggested Citation

Wang, Zhiguang and Dupoyet, Brice, A Dimension-invariant Cascade Model for VIX Futures (December 19, 2019). Available at SSRN: https://ssrn.com/abstract=3355708 or http://dx.doi.org/10.2139/ssrn.3355708

Zhiguang Wang

South Dakota State University ( email )

Box 504, Department of Economics
South Dakota State University
Brookings, SD SD 57007-0895
United States

Brice Dupoyet (Contact Author)

Florida International University - College of Business Administration - Finance ( email )

University Park, RB 209 A
11200 SW 8th Street
Miami, FL 33199
United States
305-348-3328 (Phone)
305-348-4245 (Fax)

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