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No. 780: Inferring Volatility Dynamics and Risk Premia from the S&P 500 and VIX markets

Chris Bardgett , University of Zurich and Swiss Finance Institute (SFI)
Elise Gourier , Queen Mary University of London
Markus Leippold , University of Zurich and Swiss Finance Institute (SFI)

January 5, 2016

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Abstract

This paper studies the information content of the S&P 500 and VIX markets on the volatility of the S&P 500 returns. We estimate a flexible affine model based on a joint time series of underlying indexes and option prices on both markets. An extensive model specification analysis reveals that jumps and a stochastic level of reversion for the variance help reproduce risk-neutral distributions as well as the term structure of volatility smiles and of variance risk premia. We find that the S&P 500 and VIX derivatives prices are consistent in times of market calm but contain conflicting information on the variance during market distress.

J.E.L classification codes: G12, G13, C58

Keywords:S&P 500 and VIX joint modeling, Volatility dynamics, Particle filter, Variance risk premium

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