Price discovery in the volatility index option market: A univariate GARCH approach

•Risk-neutral GARCH processes are calibrated to VIX futures returns.•Both the Gaussian, and skewed Student-t error distributions are considered.•Symmetric and asymmetric GARCH processes are considered.•The symmetric GARCH model with skewed Student-t errors produces the best fitting model, and the be...

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Bibliographic Details
Published in:Finance research letters 2022-01, Vol.44, p.102069, Article 102069
Main Authors: Venter, Pierre J, Maré, Eben
Format: Article
Language:English
Subjects:
GARCH
Option pricing
VIX
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Summary:•Risk-neutral GARCH processes are calibrated to VIX futures returns.•Both the Gaussian, and skewed Student-t error distributions are considered.•Symmetric and asymmetric GARCH processes are considered.•The symmetric GARCH model with skewed Student-t errors produces the best fitting model, and the best performing VIX option pricing model. In this paper, the GARCH option pricing model is applied to the Standard and Poor’s 500 (S&P500) Volatility Index (VIX) option pricing. The purpose is to determine whether the GARCH option pricing model can be used for price discovery in the volatility index option market. The different GARCH models are fitted to VIX futures returns. The pricing performance is tested by comparing the option prices implied by the models to market option prices. The results show that the symmetric GARCH model with skewed Student-t errors is the best performing model, and that the GARCH option pricing model provides reasonable price discovery when applied to the VIX.
ISSN:1544-6123
1544-6131
DOI:10.1016/j.frl.2021.102069