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proskurin
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Modelling VIX futures backwardation

July 17th, 2018, 7:08 am

Hi!
I have a VIX futures trading algorithm and would like to perform Monte-Carlo simulation of VIX and understand how my algorithm performs on each simulation. In this case, not only VIX should be modeled, but also futures prices. How can I model VIX futures price reaction on VIX spikes, especially backwardation? There are many papers describing Monte-Carlo modeling of VIX, but not VIX futures price reaction to VIX.
 
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bearish
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Re: Modelling VIX futures backwardation

July 17th, 2018, 10:41 am

You may want to take a look at this paper by Avellaneda and Papanicolaou:
  https://www.math.nyu.edu/faculty/avella ... 028910.pdf
 
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Alan
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Re: Modelling VIX futures backwardation

July 18th, 2018, 2:52 am

There is an interesting related issue here. 

Generally, everyone agrees that the unconditional expected return to a long VIX futures position, let's say with a 1-day holding period, is significantly negative. But, what is the sign of the expected return -- conditional on the future (say when the trade is initiated) being in backwardation?

I spend a lot of time on this question (without a definitive resolution) in Ch. 4 of "Option Valuation under Stochastic Volatility II". The problem is that (historical, average) experienced returns (to date) may be a misleading guide to expectations for this type of question. If it is misleading, this has implications for back-testing any trading system.