A Regime-Switching Heston Model for VIX and S&P 500 Implied Volatilities
Quantitative Finance, Volume 14, Issue 10, (2014) pp. 1811-1827.
27 Pages Posted: 20 Oct 2012 Last revised: 21 Sep 2014
Date Written: April 25, 2013
Abstract
Volatility products have become popular in the past 15 years as a hedge against market uncertainty. In particular, there is growing interest in options on the VIX volatility index. A number of recent empirical studies examine whether there is significantly greater risk premium in VIX option prices compared with S&P 500 option prices. We address this issue by proposing and analyzing a stochastic volatility model with regime switching. The basic Heston model cannot capture VIX implied volatilities, as has been documented. We show that the incorporation sharp regime shifts can bridge this shortcoming. We take advantage of Fourier methods to make the extension tractable, and we present a fit to data, both in times of crisis and relative calm, which shows the effectiveness of the regime switching.
Keywords: Heston model, VIX Options
JEL Classification: G12, G13, G17
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Pricing Options on Realized Variance in the Heston Model with Jumps in Returns and Volatility
By Artur Sepp
-
Derivatives on Volatility: Some Simple Solutions Based on Observables
By Steven L. Heston and Saikat Nandi
-
By Artur Sepp
-
A Closed-Form Exact Solution for Pricing Variance Swaps With Stochastic Volatility
By Song-ping Zhu and Guanghua Lian
-
Options on Realized Variance by Transform Methods: A Non-Affine Stochastic Volatility Model
-
The Term Structure of Variance Swaps and Risk Premia
By Yacine Ait-sahalia, Mustafa Karaman, ...