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A Consistent Pricing Model for Index Options and Volatility Derivatives

A consistent pricing model for index options and volatility derivatives
Authors: Cont, Rama; Kokholm, Thomas;

A Consistent Pricing Model for Index Options and Volatility Derivatives

Abstract

We propose a flexible framework for modeling the joint dynamics of an index and a set of forward variance swap rates written on this index. Our model reproduces various empirically observed properties of variance swap dynamics and enables volatility derivatives and options on the underlying index to be priced consistently, while allowing for jumps in volatility and returns. An affine specification using Lévy processes as building blocks leads to analytically tractable pricing formulas for volatility derivatives, such as VIX options, as well as efficient numerical methods for pricing of European options on the underlying asset. The model has the convenient feature of decoupling the vanilla skews from spot/volatility correlations and allowing for different conditional correlations in large and small spot/volatility moves. We show that our model can simultaneously fit prices of European options on S&P 500 across strikes and maturities as well as options on the VIX volatility index.

Countries
Denmark, France, France
Keywords

Affine processes, [MATH.MATH-PR] Mathematics [math]/Probability [math.PR], Volatility derivatives, Lévy process, affine processes, [QFIN.CP] Quantitative Finance [q-fin]/Computational Finance [q-fin.CP], volatility derivatives, Economic models of real-world systems (e.g., electricity markets, etc.), Variance swap, variance swap, Derivative securities (option pricing, hedging, etc.), No keywords;, affine processes: jump-diffusion model, VIX, Jump processes, Levy process, jump processes, Interest rates, asset pricing, etc. (stochastic models)

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    influence
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selected citations
These citations are derived from selected sources.
This is an alternative to the "Influence" indicator, which also reflects the overall/total impact of an article in the research community at large, based on the underlying citation network (diachronically).
BIP!Citations provided by BIP!
popularity
This indicator reflects the "current" impact/attention (the "hype") of an article in the research community at large, based on the underlying citation network.
BIP!Popularity provided by BIP!
influence
This indicator reflects the overall/total impact of an article in the research community at large, based on the underlying citation network (diachronically).
BIP!Influence provided by BIP!
impulse
This indicator reflects the initial momentum of an article directly after its publication, based on the underlying citation network.
BIP!Impulse provided by BIP!
100
Top 10%
Top 10%
Top 10%
Green
bronze
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