Numerix a leading provider of analytics for derivatives and structured products has released its latest version of Numerix CrossAsset. The new release aims to provide innovative model coverage for VIX futures instruments to more accurately price volatility linked derivatives. The growth of volatility as both an asset class and as a hedge has grown tremendously over the past several years, with trading volume of VIX futures setting a new annual record in 2011 with over 12 million contracts traded.
The VIX was first introduced in 1993 to track the implied volatility of certain stock market indices. In the years following, the methodology of calculating the VIX evolved to more accurately reflect how a financial practitioner could hedge such an index. In 2004, futures on the VIX became tradable and two years later VIX options were introduced, giving-rise to volatility as a full-fledged asset class.
The VIX is used by FX traders to determine the market sentiment.
It was developed by the Chicago Board Options in 1993, the VIX determines market direction by gauging investor confidence (or non-confidence).
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Today, there are VIX-like indices measuring the implied volatility of various equity and commodity indices; and many exchange-traded instruments written on the VIX. Many diverse financial products also reference the VIX, including complex variable annuities that are widespread in the Insurance sector. Because of ongoing market volatility, it’s crucial that the models used to value these trades apply a complex stochastic process that takes in to account the price and volatility dynamics implied by the VIX.
The VIX is currently trading at 16.88.
“With the possibility of actually observing implied ‘vol of vol’ due to options trading on the VIX, stochastic volatility models of stock market indices have much more stringent bounds on their behavior, helping to resolve the limitations of previous models used,” said Tom Davis, Vice President of the Client Solutions Group at Numerix. “Since the ‘vol of vol’ smile can actually be observed, sophisticated stochastic volatility models are essential in order to reproduce this type of dynamic and capture the subtleties of the VIX index.”
With CrossAsset 10.0, Numerix has further developed its VIX coverage to better model equity indices and their stochastic volatility dynamics. The Heston and Bates Equity and Commodity Models can now be calibrated to VIX futures and options taking in to account the volatility of volatility term structure for pricing and risk.
“Volatility has become a full-blown asset class and managing its complexities has remained a challenge for customers over the past several years – not only from a hedging perspective but also from a modeling point-of-view,” said Steve O’Hanlon, President & COO of Numerix. “With the most extensive collection of models and methods, we’re proud of our industry leading position and the continuous innovation we bring to the marketplace. By incorporating further VIX coverage into our hybrid model and structuring framework, clients now have a broader range of capabilities for pricing and valuation services.”