Inferring information from the S&P 500, CBOE VIX, and CBOE SKEW indices

Abstract

This paper compares the information extracted from the S&P 500, CBOE VIX, and CBOE SKEW indices for the S&P 500 index option pricing. Based on our empirical analysis, VIX is a very informative index for option prices. Whether adding the SKEW or the VIX term structure can improve the option pricing performance depends on the model we choose. Roughly speaking, the VIX term structure is informative for some models, while the SKEW is very noisy and does not contain much important information for option prices. This paper also extends Zhang et al.(2017, J Futures Markets, 37, 211-237) into three typical affine models.

VIX term structure: The role of jump propagation risks

“…In the literature, the study closest to ours is that of Cao et al (2020). Using the Hawkes jump model, Cao et al (2020) extract information from VIX data for index option pricing.…”

“…In the literature, the study closest to ours is that of Cao et al (2020). Using the Hawkes jump model, Cao et al (2020) extract information from VIX data for index option pricing. Our study complements that of Cao et al (2020) by modeling the stochastic central tendency of the instantaneous variance, that is, the long‐term variance factor.…”

“…In Equation (2), we describe the DGP of short‐term with a variance jump component , shown to be important for pricing variance assets in previous studies (e.g., Aït‐Sahalia et al, 2020; Bardgett et al, 2019; Gehricke & Zhang, 2020). Unlike Liu and Zhu (2019) and Cao et al (2020), we allow for a stochastic central tendency of the instantaneous variance in Equation (3). Egloff et al (2010), Luo and Zhang (2012), Elkamhi et al (2016), Gehricke and Zhang (2020), and many others show that the use of stochastic is useful for capturing the term structure of financial derivatives.…”

“…Filipović et al (2016) show that the term structure of variance swap rates provides important information for managing variance risk. Cao et al (2020) point out that valuable information is embedded in the VIX term structure and can improve the pricing performance of index options. In addition, Egloff et al (2010) and Elkamhi et al (2016) demonstrate that analyzing the variance term structure is beneficial for optimizing the investment strategy and improving investment performance.…”

“…Using the Hawkes jump model, Cao et al (2020) extract information from VIX data for index option pricing. Our study complements that of Cao et al (2020) by modeling the stochastic central tendency of the instantaneous variance, that is, the long‐term variance factor. However, our study uses more VIX data with different maturities and focuses on the impact of jump propagation risks on the VIX term structure.…”