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New Approach to Estimating VIX Truncation Errors Using Corridor Variance Swaps
Stockholm University, Faculty of Social Sciences, Stockholm Business School. University of Chinese Academy of Sciences, China.
Number of Authors: 22018 (English)In: Journal of Derivatives, ISSN 1074-1240, E-ISSN 2168-8524, Vol. 25, no 4, p. 54-70Article in journal (Refereed) Published
Abstract [en]

An approach to estimating the volatility index (VIX) truncation error using corridor variance swaps (CVSs) is developed. It is shown that the existing VIX approach significantly underestimates option volatility in emerging markets. The truncation error of iVX (a product that mimics VIX in China's options market) is not only significant, but also volatile under different market conditions. It is demonstrated that other emerging markets, such as Korea and Mexico, also have significant VIX truncation errors. A new approach, different from the popular Fast Fourier Transform (FFT), is proposed for the valuation of corridor variance swaps. The Feynman-Kac connection is employed to derive a closed-form result and avoid the arbitrary damping factor (alpha) problem in the FFT approach.

Place, publisher, year, edition, pages
2018. Vol. 25, no 4, p. 54-70
National Category
Economics and Business
Identifiers
URN: urn:nbn:se:su:diva-157684DOI: 10.3905/jod.2018.1.066ISI: 000434062800006OAI: oai:DiVA.org:su-157684DiVA, id: diva2:1236025
Available from: 2018-07-30 Created: 2018-07-30 Last updated: 2018-07-30Bibliographically approved

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