Diagnosing affine models of options pricing: Evidence from VIX

Gang Li, Chu Zhang

Research output: Journal article publicationJournal articleAcademic researchpeer-review

5 Citations (Scopus)

Abstract

Affine jump-diffusion models have been the mainstream in options pricing because of their analytical tractability. Popular affine jump-diffusion models, however, are still unsatisfactory in describing the options data and the problem is often attributed to the diffusion term of the unobserved state variables. Using prices of variance-swaps (i.e., squared VIX) implied from options prices, we provide fresh evidence regarding the misspecification of affine jump-diffusion models, as variance-swap prices are affine functions of the state variables in a broader class of models that do not restrict the diffusion term of the state variables. We apply the nonparametric methodology used by Aït-Sahalia (1996b), supplemented with bootstrap tests and other parametric tests, to the S&P 500 index options data from January 1996 to September 2008. We find that, while the affine diffusion term of the state variables may contribute to the misspecification as the literature has suggested, the affine drift of the state variables, jump intensities, and risk premiums are also sources of misspecification.
Original languageEnglish
Pages (from-to)199-219
Number of pages21
JournalJournal of Financial Economics
Volume107
Issue number1
DOIs
Publication statusPublished - 1 Jan 2013

Keywords

  • Affine jump-diffusion models
  • Options pricing
  • Variance-swap prices

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Cite this