FRIC/Finance Seminar with Bjørn Eraker, University of Wisconsin-Madison

The Department of Finance and FRIC, Center for Financial Frictions, are proud to announce the upcoming seminar with Bjørn Eraker, Wisconsin School of Business, University of Wisconsin-Madison.

Bjørn Eraker will present:

The Price of Higher Order Catastrophe Insurance: The Case of VIX Options

ABSTRACT
We develop an equilibrium pricing model aimed at explaining observed characteristics in equity returns, VIX futures and VIX options data. To derive our model we first specify a general framework based on affine jump-diffusive state-dynamics and agents endowed with Duffie-Epstein recursive utility. This allows us to derive moments of equity returns under the objective and risk-neutral measures, and subsequently semi-closed form solutions to prices of equity options, VIX futures, and VIX options. We calibrate this model to fit the salient features of the data, including moments of consumption and equity returns, and various features of VIX derivatives data. The model matches the extremely right skewed volatility smiles seen in VIX options, a downward sloping term-structure of implied Black '76 volatilities, large negative rates of return on VIX futures, and negative VIX option risk premia. It also matches other characteristics of VIX options data, including time-variation in the shape of implied volatilities.