A Multi-Factor Transformed Diffusion Model with Applications to VIX and VIX Futures

Bu, R ORCID: 0000-0002-3947-3038, Jawadi, Fredj and Li, Yuyi
(2020) A Multi-Factor Transformed Diffusion Model with Applications to VIX and VIX Futures. Econometric Reviews, 39 (1). pp. 27-53.

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Transformed diffusions (TDs) have become increasingly popular in financial modeling for their model flexibility and tractability. While existing TD models are predominately one-factor models, empirical evidence often prefers models with multiple factors. We propose a novel distribution-driven nonlinear multifactor TD model with latent components. Our model is a transformation of a underlying multivariate Ornstein–Uhlenbeck (MVOU) process, where the transformation function is endogenously specified by a flexible parametric stationary distribution of the observed variable. Computationally efficient exact likelihood inference can be implemented for our model using a modified Kalman filter algorithm and the transformed affine structure also allows us to price derivatives in semi-closed form. We compare the proposed multifactor model with existing TD models for modeling VIX and pricing VIX futures. Our results show that the proposed model outperforms all existing TD models both in the sample and out of the sample consistently across all categories and scenarios of our comparison.

Item Type: Article
Uncontrolled Keywords: Transformation model, nonlinear diffusion, latent factor, Kalman filter, volatility index
Depositing User: Symplectic Admin
Date Deposited: 06 Jul 2020 15:49
Last Modified: 18 Jan 2023 23:47
DOI: 10.1080/07474938.2019.1690195
Related URLs:
URI: https://livrepository.liverpool.ac.uk/id/eprint/3092555

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