Weak approximations and VIX option price expansions in forward variance curve models

TL;DR

This paper develops explicit approximation formulas for VIX futures and options within forward variance models, especially Bergomi models, using weak approximation techniques that handle fractional kernels and non-smooth payoffs, applicable across various maturities.

Contribution

It introduces a novel weak approximation approach for VIX derivatives in rough volatility models, accommodating fractional kernels and non-smooth payoffs without relying on small-time asymptotics.

Findings

Accurate explicit formulas for VIX options in complex models

Effective handling of fractional kernels and non-smooth payoffs

Numerical results show good calibration to market data

Abstract

We provide explicit approximation formulas for VIX futures and options in forward variance models, with particular emphasis on the family of so-called Bergomi models: the one-factor Bergomi model [Bergomi, Smile dynamics II, Risk, 2005], the rough Bergomi model [Bayer, Friz, and Gatheral, Pricing under rough volatility, Quantitative Finance, 16(6):887-904, 2016], and an enhanced version of the rough model that can generate realistic positive skew for VIX smiles -- introduced simultaneously by De Marco [Bachelier World Congress, 2018] and Guyon [Bachelier World Congress, 2018] on the lines of [Bergomi, Smile dynamics III, Risk, 2008], that we refer to as 'mixed rough Bergomi model'. Following the methodology set up in [Gobet and Miri, Weak approximation of averaged diffusion processes. Stochastic Process.\ Appl., 124(1):475-504, 2014], we derive weak approximations for the law of the VIX, leading to option price approximations under the form of explicit combinations of Black-Scholes prices and greeks. As new contributions, we cope with the fractional integration kernel appearing in rough models and treat the case of non-smooth payoffs, so to encompass VIX futures, call and put options. We stress that our approach does not rely on small-time asymptotics nor small-parameter (such as small volatility-of-volatility) asymptotics, and can therefore be applied to any option maturity and a wide range of parameter configurations. Our results are illustrated by several numerical experiments and calibration tests to VIX market data.