Bounds for VIX futures given S{\&}P 500 smiles

DOI10.1007/S00780-017-0334-6MaRDI QIDQ2364530zbMATH OpenOpenAlexFDO

Authors Julien Guyon, Romain Menegaux, Marcel Nutz

Publication date 21 July 2017

Published in Finance and Stochastics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1609.05832

zbMATH Keywords

model-free pricingprice boundsrobust hedgingVIX futures

Mathematics Subject Classification ID

Linear optimal control problems (49N05) Martingales with discrete parameter (60G42) Portfolio theory (91G10) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: We derive sharp bounds for the prices of VIX futures using the full information of S&P 500 smiles. To that end, we formulate the model-free sub/superreplication of the VIX by trading in the S&P 500 and its vanilla options as well as the forward-starting log-contracts. A dual problem of minimizing/maximizing certain risk-neutral expectations is introduced and shown to yield the same value. The classical bounds for VIX futures given the smiles only use a calendar spread of log-contracts on the S&P 500. We analyze for which smiles the classical bounds are sharp and how they can be improved when they are not. In particular, we introduce a family of functionally generated portfolios which often improves the classical bounds while still being tractable; more precisely, determined by a single concave/convex function on the line. Numerical experiments on market data and SABR smiles show that the classical lower bound can be improved dramatically, whereas the upper bound is often close to optimal.

Review text

The authors study the problem of upper and lower bounds for future contracts having the popular VIX volatility index as underlying. Although the squared VIX may be replicated with calls and puts on S\&P500, VIX itself cannot, raising the need for sharp upper and lower bounds. This is typically done via affine payoff functions that produce a totally unsatisfactory zero lower bound. The authors exploit the classical duality approach to the problem which requires the proof of absence of a duality gap which is the main theoretical result of the paper. Since the replicating portfolio that arise from this approach are difficult to implement, the authors also develop what they call ``functionally generated portfolios which have an easier implementation and still produce a great improvement particularly for what concerns the lower bound on the VIX future.

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Cited in

(14)

• Pricing bounds for volatility derivatives via duality and least squares Monte Carlo
• A risk-neutral equilibrium leading to uncertain volatility pricing
• Applications of weak transport theory
• Stability of martingale optimal transport and weak optimal transport
• Trading signals in VIX futures
• Volatility options in rough volatility models
• The VIX Future in Bergomi Models: Fast Approximation Formulas and Joint Calibration with S&P 500 Skew
• Stability of the weak martingale optimal transport problem
• Dispersion-constrained martingale Schrödinger problems and the exact joint S\&P 500/VIX smile calibration puzzle
• An optimal transport-based characterization of convex order
• The Wasserstein space of stochastic processes
• Rough multi-factor volatility for SPX and VIX options
• Dispersion-constrained martingale Schrödinger bridges: joint entropic calibration of stochastic volatility models to S\&P 500 and VIX smiles
• The McCormick martingale optimal transport

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