Markets' Notion on Implied Volatility Risks: Insights from Model-Free VIX Futures Pricing

File pdf 898KB

This paper studies the interdependencies between the VIX futures market and the S&P500 and VIX options markets using a model-free pricing method for VIX futures. We show that the replication strategy for the VIX futures deviates strongly from observed prices. Limited strike ranges do not suffice to reason these deviations, whereas liquidity risks can explain most of it. After controlling for liquidity by constructing higher and lower bounds for the VIX futures price, we find a lead-lag structure between markets segmented by product, not by its underlying. Our model-free analysis shows that if option markets imply higher volatility risks relative to VIX futures, option prices in both markets adjust and vice versa.

Author(s):

Hendrik Hülsbusch    
Finance Center Muenster
Germany

Alexander Kraftschik    
Finance Center Muenster
Germany