Discussion Paper

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.

Keywords: variance swaps; VIX futures; term structures; variance risk premium; return predictability;

JEL Classification: G1;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2021-02-01

Number: 20210201