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

150 Pages Posted: 5 Feb 2020 Last revised: 24 Sep 2021

See all articles by Bjorn Eraker

Bjorn Eraker

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

Aoxiang Yang

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

Date Written: January 15, 2020

Abstract

We develop a tractable equilibrium pricing model to explain observed characteristics in equity returns, VIX futures, S&P 500 options, and VIX options data based on affine jump- diffusive state dynamics and representative agents endowed with Duffie-Epstein recursive preferences. A specific model aimed at capturing VIX options prices and other asset market data is shown to successfully replicate the salient features of consumption, dividends, and asset market data, including the first two moments of VIX futures returns, the average implied volatilities in SPX and VIX options, and first and higher-order moments of VIX options returns. We document a time variation in the shape of VIX option implied volatility and a time-varying hedging relationship between VIX and SPX options which our model both captures.

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). Journal of Finance, Forthcoming, 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

Peking University ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

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

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

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