The Law of One Price in Equity Volatility Markets

71 Pages Posted: 23 Dec 2020

See all articles by Peter Van Tassel

Peter Van Tassel

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: December 2020

Abstract

This paper documents law of one price violations in equity volatility markets. While tightly linked by no-arbitrage restrictions, the prices of VIX futures exhibit significant deviations relative to their option-implied upper bounds. Static arbitrage opportunities occur when the prices of VIX futures violate their bounds. The deviations widen during periods of market stress and predict the returns of VIX futures. A relative value trading strategy based on the deviation measure earns a large Sharpe ratio and economically significant alpha-to-margin. There is evidence that systematic risk and demand pressure contribute to the variation in the no-arbitrage deviations over time.

Keywords: limits-to-arbitrage, VIX futures, variance swaps, volatility, return predictability

JEL Classification: G12, G13, C58

Suggested Citation

Van Tassel, Peter, The Law of One Price in Equity Volatility Markets (December 2020). FRB of New York Staff Report No. 953, Available at SSRN: https://ssrn.com/abstract=3751612 or http://dx.doi.org/10.2139/ssrn.3751612

Peter Van Tassel (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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