The Price of Higher Order Catastrophe Insurance: The Case of VIX Options

79 Pages Posted: 5 Feb 2020

See all articles by Bjorn Eraker

Bjorn Eraker

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Aoxiang Yang

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Date Written: January 15, 2020

Abstract

We develop an equilibrium pricing model aimed at explaining observed characteristics in equity returns, VIX futures and VIX options data. To derive our model we first specify a general framework based on affine jump-diffusive state-dynamics and representative agent endowed with Duffie-Epstein recursive utility. This allows us to derive moments of equity returns under the objective and risk-neutral measures, and subsequently semi-closed form solutions to prices of equity options, VIX futures, and VIX options. We calibrate this model to fit the salient features of the data, including moments of consumption and equity returns, variance premium, and various features of VIX derivatives data. The model matches the extremely right-skewed volatility smiles seen in VIX options, a downward-sloping term structure of implied Black'76 volatilities, large negative rates of return on VIX futures, and large VIX option risk premia. It also matches other characteristics of VIX options data, including time-variation in the shape of implied volatilities.

Keywords: VIX, VIX options, Dynamic Equilibrium, Duffie-Epstein, Variance Risk Premium

JEL Classification: G00, G10, G12, G13

Suggested Citation

Eraker, Bjorn and Yang, Aoxiang, The Price of Higher Order Catastrophe Insurance: The Case of VIX Options (January 15, 2020). Available at SSRN: https://ssrn.com/abstract=3520256 or http://dx.doi.org/10.2139/ssrn.3520256

Bjorn Eraker (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States

Aoxiang Yang

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

MADISON, WI 53703
6083347203 (Phone)
53703 (Fax)

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
52
Abstract Views
788
rank
407,764
PlumX Metrics