Specification analysis of VXX option pricing models under Lévy processes

Abstract

We conduct a comprehensive study on the specifications of VXX option pricing models under Lévy processes during the period from 2010 to 2017 based on in‐sample and out‐of‐sample performance tests. Our empirical results imply that a jump component plays an important role in VXX option pricing. In particular, we find that infinite‐activity jump models are superior to finite‐activity jump models. More importantly, this paper corrects the VXX option pricing theory in the literature; that is the discounted VXX price should be a martingale under the risk‐neutral measure as the VXX is an exchange‐traded debt security.

Pricing VXX options by modeling VIX directly

“…Tan et al (2021) propose a comprehensive jump‐to‐default extended two‐factor stochastic volatility plus asymmetry jumps model for the valuation of VXX derivatives. Cao et al (2021) conduct a comprehensive study on the specifications of VXX option pricing models under Lévy processes. However, a direct modeling approach in VXX cannot explain the systematical loss of VXX, which is obviously observable in the VXX market.…”