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economics
28May

“What do Returns of VIX Puts Reveal About the Volatility Market?” by Gurdip Bakshi

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Authors:

  • Gurdip Bakshi
    University of Maryland

  • George Panayotov
    Georgetown University

  • Dilip Madan
    University of Maryland

 

The average returns of traded out-of-the-money VIX puts in our sample are negative in the tail and increase in strike, inconsistent with a theory where the pricing kernel is monotonically decreasing in the market return and increasing in market volatility. Exploring the implications of these findings, we propose a model of the volatility market that assumes two types of investors, who optimally choose volatility contingent cash flows under heterogeneity in beliefs about volatility outcomes. Based on the derived pricing kernel, the pricing density can dominate the physical density in both tails of the volatility distribution, potentially generating a large negative premium for deep out-of-the-money VIX puts. The documented features of VIX option returns can be supported in example economies under certain parameterizations of investors' belief distributions.

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“What do Returns of VIX Puts Reveal About the Volatility Market?” by Gurdip Bakshi
Friday, 28 May 2010
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