Department of Economics and Business Economics

The Short-Time Behaviour of VIX Implied Volatilities in a Multifactor Stochastic Volatility Framework

Research output: Research - peer-reviewWorking paper

We consider a modelling setup where the VIX index dynamics are explicitly computable as a smooth transformation of a purely diffusive, multidimensional Markov process. The framework is general enough to embed many popular stochastic volatility models. We develop closed-form expansions and sharp error bounds for VIX futures, options and implied volatilities. In particular, we derive exact asymptotic results for VIX implied volatilities, and their sensitivities, in the joint limit of short time-to-maturity and small log-moneyness. The obtained expansions are explicit, based on elementary functions and they neatly uncover how the VIX skew depends on the specific choice of the volatility and the vol-of-vol processes. Our results are based on perturbation techniques applied to the infinitesimal generator of the underlying process. This methodology has been previously adopted to derive approximations of equity (SPX) options. However, the generalizations needed to cover the case of VIX options are by no means straightforward as the dynamics of the underlying VIX futures are not explicitly known. To illustrate the accuracy of our technique, we provide numerical implementations for a selection of model specifications.
Original languageEnglish
PublisherSocial Science Research Network (SSRN)
Number of pages31
StatePublished - 30 Mar 2017

    Research areas

  • VIX Options, Multifactor Stochastic Volatility, Asymptotic Expansions

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