Market-based estimation of stochastic volatility models

Yacine Aït-Sahalia, Dante Amengual, Elena Manresa

    Research output: Contribution to journalArticle

    Abstract

    We propose a method for estimating stochastic volatility models by adapting the HJM approach to the case of volatility derivatives. We characterize restrictions that observed variance swap dynamics have to satisfy to prevent arbitrage opportunities. When the drift of variance swap rates are affine under the pricing measure, we obtain closed form expressions for those restrictions and formulas for forward variance curves. Using data on the S&P500 index and variance swap rates on different time to maturities, we find that linear mean-reverting one factor models provide inaccurate representation of the dynamics of the variance swap rates while two-factor models significantly outperform the former both in and out of sample.

    Original languageEnglish (US)
    Pages (from-to)418-435
    Number of pages18
    JournalJournal of Econometrics
    Volume187
    Issue number2
    DOIs
    StatePublished - Aug 1 2015

    Fingerprint

    Variance swap
    Stochastic volatility model
    Time to maturity
    Derivatives
    Mean-reverting
    Arbitrage
    Pricing

    Keywords

    • HJM approach
    • Maximum likelihood estimation
    • Variance swaps

    ASJC Scopus subject areas

    • Economics and Econometrics

    Cite this

    Market-based estimation of stochastic volatility models. / Aït-Sahalia, Yacine; Amengual, Dante; Manresa, Elena.

    In: Journal of Econometrics, Vol. 187, No. 2, 01.08.2015, p. 418-435.

    Research output: Contribution to journalArticle

    Aït-Sahalia, Y, Amengual, D & Manresa, E 2015, 'Market-based estimation of stochastic volatility models', Journal of Econometrics, vol. 187, no. 2, pp. 418-435. https://doi.org/10.1016/j.jeconom.2015.02.028
    Aït-Sahalia, Yacine ; Amengual, Dante ; Manresa, Elena. / Market-based estimation of stochastic volatility models. In: Journal of Econometrics. 2015 ; Vol. 187, No. 2. pp. 418-435.
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