Pricing VIX Derivatives with Infinite-Activity Jumps

46 Pages Posted: 11 Nov 2019

See all articles by Jiling Cao

Jiling Cao

Auckland University of Technology

Xinfeng Ruan

University of Otago - Department of Accountancy and Finance

Shu Su

Auckland University of Technology

wenjun zhang

Auckland University of Technology

Date Written: October 30, 2019

Abstract

In this paper, we investigate a two-factor VIX model with infinite-activity jumps, which is a more realistic way to reduce errors in pricing VIX derivatives, compared with Mencía and Sentana (2013). Our two-factor model features central tendency, stochastic volatility and infinite-activity pure jump Lévy processes which include the variance gamma (VG) and the normal inverse Gaussian (NIG) processes as special cases. We find empirical evidence that the model with infinite-activity jumps is superior to the models with finite-activity jumps, particularly in pricing VIX options. As a result, infinite-activity jumps should not be ignored in pricing VIX derivatives.

Keywords: Infinite-activity jumps, VIX derivatives, unscented Kalman filter, maximum log-likelihood estimation

JEL Classification: G12, G13

Suggested Citation

Cao, Jiling and Ruan, Xinfeng and Su, Shu and zhang, wenjun, Pricing VIX Derivatives with Infinite-Activity Jumps (October 30, 2019). Available at SSRN: https://ssrn.com/abstract=3478340 or http://dx.doi.org/10.2139/ssrn.3478340

Jiling Cao

Auckland University of Technology ( email )

AUT City Campus
Private Bag 92006
Auckland, 1142
New Zealand

Xinfeng Ruan

University of Otago - Department of Accountancy and Finance ( email )

PO Box 56
Dunedin
New Zealand

HOME PAGE: http://sites.google.com/site/ruanxinf/

Shu Su

Auckland University of Technology ( email )

AUT City Campus
Private Bag 92006
Auckland, 1142
New Zealand

Wenjun Zhang (Contact Author)

Auckland University of Technology ( email )

AUT City Campus
Private Bag 92006
Auckland, 1142
New Zealand

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