Pricing VXX option with default risk and positive volatility skew

Qunfang Bao, Shenghong Li and Donggeng Gong

European Journal of Operational Research, 2012, vol. 223, issue 1, 246-255

Abstract: This paper proposes and makes a comparative study of alternative models for VXX option pricing. Factors such as mean-reversion, jumps, default risk and positive volatility skew are taken into consideration. In particular, default risk is characterized by jump-to-default framework and the “positive volatility skew” issue is addressed by stochastic volatility of volatility and jumps. Daily calibration is conducted and comparative study of the models is performed to check whether they properly fit market prices and generate reasonable positive volatility skews and deltas. Overall, jump-to-default extended LRJ model with positive correlated stochastic volatility (called JDLRJSV in the paper) serves as the best model in all the required aspects.

Keywords: Pricing; ETN; VXX options; Positive volatility skew; Jump-to-default (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:223:y:2012:i:1:p:246-255

DOI: 10.1016/j.ejor.2012.06.006

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