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The Law of One Price in Equity Volatility Markets

Peter Van Tassel

No 953, Staff Reports from Federal Reserve Bank of New York

Abstract: This paper documents law of one price violations in equity volatility markets. While tightly linked by no-arbitrage restrictions, the prices of VIX futures exhibit significant deviations relative to their option-implied upper bounds. Static arbitrage opportunities occur when the prices of VIX futures violate their bounds. The deviations widen during periods of market stress and predict the returns of VIX futures. A relative value trading strategy based on the deviation measure earns a large Sharpe ratio and economically significant alpha-to-margin. There is evidence that systematic risk and demand pressure contribute to the variation in the no-arbitrage deviations over time.

Keywords: limits-to-arbitrage; VIX futures; variance swaps; volatility; return predictability (search for similar items in EconPapers)
JEL-codes: C58 C59 G12 G13 (search for similar items in EconPapers)
Pages: 71
Date: 2020-12-01
New Economics Papers: this item is included in nep-fmk and nep-rmg
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Working Paper: The Law of One Price in Equity Volatility Markets (2021) Downloads
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