The Law of One Price in Equity Volatility Markets
Abstract: Can option traders take a square root? Surprisingly, maybe not. This post shows that VIX futures prices exhibit significant deviations from their option-implied upper bounds—the square root of variance swap forward rates—thus violating the law of one price, a fundamental concept in economics and finance. The deviations widen during periods of market stress and predict the returns of VIX futures. Just as the stock market struggles with multiplication, the equity volatility market appears unable to take a square root at times.
JEL Classification: G1;
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Description: Full text
Provider: Federal Reserve Bank of New York
Part of Series: Liberty Street Economics
Publication Date: 2021-02-01