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
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