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A Rough Instantaneous Squared VIX Model for Term Structure and Option Pricing

Abstract

The VIX term structure provides forward-looking measures of market uncertainty across horizons, while VIX options allow investors to hedge volatility risk. This paper proposes a rough instantaneous squared VIX (RISVIX) model by introducing fractional memory into the conventional Markovian framework. We derive an explicit representation of the VIX term structure governed by Mittag–Leffler decay and a semi-closed-form pricing formula for VIX options based on an affine Fourier–Laplace transform. These results support a two-step calibration procedure that estimates memory, mean reversion, and date-specific initial states from VIX term-structure indices before calibrating the remaining distributional parameters to VIX option prices. Using daily VIX term-structure indices and VIX option quotes from January 2018 to June 2025, we find that RISVIX improves upon the Markovian benchmark in fitting the VIX term structure, with larger gains during elevated-volatility periods and for its slope and curvature. RISVIX also improves out-of-sample option pricing, reducing MSE and MAE by 13.06% and 6.33%, respectively, with larger gains at shorter maturities and in high-VIX states. These findings suggest that the gains from fractional memory are particularly pronounced when volatility is elevated and can be obtained within a tractable direct model of VIX derivatives. Comparisons with additional benchmarks from the recent literature also show improvements to varying degrees in both VIX term-structure fitting and option pricing.

JEL Classification: G12, G13

Introduction

Since the global financial crisis of 2008, the VIX has become a central gauge of financial-market uncertainty and the reference index for a major market in volatility derivatives (Whaley [28], Luo et al. [23]). The index itself is not directly tradable: it is calculated from S&P 500 option prices and summarizes the market’s risk-neutral expectation of S&P 500 variation over the next 30 days (Luo and Zhang [22]). Tradable exposure is instead provided by VIX futures and options, which allow investors to hedge volatility risk and take directional positions on changes in market uncertainty (Luo et al. [23]). At the same time, evidence that volatility exhibits rough, non-Markovian dynamics has prompted growing interest in the implications of roughness for VIX futures and options (Gatheral et al. [14], Jacquier et al. [18], Rømer [27]). The prominence of the VIX market, together with this evidence, creates a need for models that can capture the dynamics of the VIX while remaining sufficiently tractable for derivative pricing.1

Existing models for VIX derivatives can be organized into two broad approaches. The first derives VIX from the joint risk-neutral dynamics of the S&P 500 and its latent variance process, thereby maintaining a structural link between SPX and VIX derivatives, but often requiring a relatively rich specification and joint calibration to both markets [30, 31, 9, 20, 4, 13]. The second approach models variance, volatility, VIX, or VIX futures directly [21, 22, 26, 17, 23] (Dupoyet et al. 2011). By avoiding an explicit model for the SPX spot price, direct specifications are generally more parsimonious and yield more tractable VIX derivative prices, although they do not impose a structural link between the equity and volatility markets.

This paper follows the instantaneous squared VIX (ISVIX) approach developed by Luo and Zhang [22], Luo et al. [23], which models directly the short-horizon limiting object whose conditional average determines squared VIX. The resulting Markovian specification is parsimonious and tractable, but it restricts the transmission of current volatility conditions across maturities to the pattern implied by exponential mean reversion. A natural way to relax this restriction is to introduce memory. Rough-volatility models use singular fractional kernels to capture the low local regularity and history dependence observed in volatility dynamics [5, 14, 12]. Most applications to VIX derivatives, however, introduce roughness into the latent variance or forward-variance process of the equity index and then derive VIX as a nonlinear functional of that process. This route is well suited to joint SPX–VIX modeling, but it makes the VIX term structure and VIX option prices depend on a comparatively rich latent-state system.

We instead propose a rough instantaneous squared VIX (RISVIX) model, by introducing a fractional Volterra kernel directly into the ISVIX framework of Luo et al. [23]. We derive an explicit VIX term structure governed by a Mittag–Leffler decay function and a semi-closed pricing formula for VIX options based on an affine Fourier–Laplace transform. These results lead to a two-step procedure in which the VIX term structure is used to estimate the memory and mean-reversion parameters, while VIX options are used to calibrate the remaining distributional parameters. Empirically, we estimate RISVIX using VIX term-structure indices and VIX option prices from 2018 to 2025. The gains from fractional memory vary substantially with market conditions. RISVIX improves the fit of the VIX term structure, with larger gains for its slope and curvature and during periods of elevated volatility. It also improves out-of-sample VIX option pricing, reducing MSE and MAE by 13.06% and 6.33%, respectively, with larger gains at shorter maturities and in high-VIX states.

Our contributions are threefold. First, we introduce fractional memory into an ISVIX model, yielding a parsimonious rough framework for modeling the VIX term structure and pricing VIX options. Second, we retain the tractability of direct VIX modeling by deriving an explicit term-structure formula and a semi-closed-form option-pricing formula, which together support a transparent two-step estimation and calibration procedure. Third, we show empirically that the gains from fractional memory vary substantially across volatility regimes: RISVIX improves the fit of the VIX term structure and the out-of-sample pricing of VIX options more strongly when volatility is elevated.

Related literature. Our paper is related to two strands of literature. First, it contributes to the literature on direct modeling of VIX term structures and derivatives. Lin [21] price VIX futures by integrating information under the physical and risk-neutral measures, while Dupoyet et al. (2011) develop a direct volatility-futures model and compare CEV and CIR specifications with and without jumps. Huskaj and Nossman [17] model the term structure of VIX futures directly rather than deriving it from an equity-variance process, and Mencía and Sentana [26] conduct an extensive empirical evaluation of VIX derivative valuation models across different market conditions. More closely related to our work, Luo and Zhang [22] extend VIX to arbitrary horizons and introduce instantaneous and long-term squared VIX as the short- and long-maturity limits of the VIX term structure. Building on this representation, Luo et al. [23] develop a unified Markovian ISVIX model with a stochastic mean level and jumps for pricing VIX derivatives across horizons. RISVIX extends their framework by replacing the propagation pattern implied by Markovian mean reversion with a fractional one.

Second, our paper contributes to the literature on rough volatility and VIX derivatives. Rough-volatility models use fractional kernels to capture the low local regularity and history dependence of volatility [5, 14, 12]. Existing applications to VIX derivatives generally specify rough dynamics for the latent variance or forward-variance curve of the equity index and then derive VIX from that process [18, 16, 27, 8, 19]. The closest study is Ye et al. (2026), who derive the VIX term structure from rough Heston using a Markovian approximation. Our RISVIX differs from their approach in two respects. First, it retains the fractional Volterra kernel directly in the ISVIX dynamics, thereby preserving the non-Markovian memory structure without relying on a Markovian approximation. Second, its affine Volterra structure yields a semi-closed pricing formula for VIX options, allowing the VIX term structure and option prices to be studied within the same framework.

The remainder of the paper is organized as follows. § 2 reviews the ISVIX framework, fractional Brownian motion and affine Volterra processes. § 3 introduces RISVIX, derives the VIX term structure and option-pricing formula, and presents the estimation procedure. § 4 reports the empirical results for the VIX term structure and VIX options. § 5 concludes. The Appendix contains the proofs and auxiliary results.

Preliminaries

This section reviews instantaneous squared VIX, fractional Brownian motion and affine Volterra models, which will be used throughout this paper. We work on a filtered probability space (Ω,F,(Ft)t≥0,Q)(\Omega,\mathcal{F},(\mathcal{F}_t)_{t\ge0},\mathbb{Q}) satisfying the usual conditions, where Q\mathbb{Q} is a risk-neutral measure. Write EtQ[⋅]=EQ[⋅∣Ft].\mathbb{E}^{\mathbb{Q}}_t[\cdot] = \mathbb{E}^{\mathbb{Q}}[\cdot\mid\mathcal{F}_t].

Instantaneous Squared VIX

Let StS_t be a strictly positive semimartingale representing the equity index. We use the continuous-strike idealisation of VIX, whose squared value over a horizon τ>0\tau> 0 is represented by the log contract ([21, 22]):

VIXt,τ2=2τEtQ[∫tt+τdSsSs−−log⁡(St+τSt)].(1)\mathrm{VIX}_{t,\tau}^{2} = \frac{2}{\tau}\mathbb{E}^{\mathbb{Q}}_t\left[\int_t^{t+\tau}\frac{\mathrm{d}S_s}{S_{s-}}-\log\left(\frac{S_{t+\tau}}{S_t}\right)\right]. \tag*{(1)}

Suppose that the continuous component of the index return has instantaneous variance vtv_t, while log-price jumps have intensity λtx\lambda_t^x and sizes distributed as a random variable xx with a state-independent law. When the integrated variance and jump correction have finite expectations, Equation (1) admits the instantaneous squared VIX (ISVIX) representation of Luo and Zhang [22]:

Vt=vt+2λtxEQ[ex−1−x],VIXt,τ2=1τEtQ[∫tt+τVs ds].(2)V_t = v_t + 2\lambda_t^x\mathbb{E}^{\mathbb{Q}}\left[e^x-1-x\right], \qquad\mathrm{VIX}_{t,\tau}^{2} = \frac{1}{\tau}\mathbb{E}^{\mathbb{Q}}_t\left[\int_t^{t+\tau}V_s\,\mathrm{d}s\right]. \tag*{(2)}

If VV is right-continuous in L1(Q)L^1(\mathbb{Q}), then VIXt,τ2→Vt\mathrm{VIX}_{t,\tau}^{2}\to V_t in L1(Q)L^1(\mathbb{Q}) as τ↓0\tau\downarrow0. ISVIX coincides with the instantaneous diffusive variance in the absence of price jumps and otherwise includes a jump correction ([23]).

Fractional Brownian Motion and Fractional Kernels

A standard fractional Brownian motion (fBM) with Hurst parameter H∈(0,1)H\in(0,1) is a centred Gaussian process BHB^H with covariance ([25])

EQ[BsHBtH]=12(s2H+t2H−∣t−s∣2H),s,t≥0.(3)\mathbb{E}^{\mathbb{Q}}\left[B_s^H B_t^H\right] = \frac{1}{2}\left(s^{2H}+t^{2H}-|t-s|^{2H}\right), \qquad s,t\ge0. \tag*{(3)}

It has stationary increments and admits sample paths that are locally Hölder continuous of every order strictly less than HH. The case H=1/2H=1/2 is standard Brownian motion, whereas H<1/2H<1/2 gives rougher paths.

We restrict attention to H∈(0,1/2]H\in(0,1/2] and set α=H+1/2\alpha=H+1/2. The corresponding fractional kernel is K(t)=tα−1/Γ(α)K(t)=t^{\alpha-1}/\Gamma(\alpha) for t>0t>0, where Γ\Gamma is the gamma function. For a standard Brownian motion BB, define

B~tH=∫0tK(t−s) dBs.(4)\widetilde{B}_t^H = \int_0^t K(t-s)\,\mathrm{d}B_s. \tag*{(4)}

For H<1/2H<1/2, this Riemann–Liouville process differs from standard fBM: its increments are not stationary, although its paths have the same local Hölder regularity ([5]). Since KK is square-integrable on every bounded interval for α>1/2\alpha>1/2, the convolution is a Brownian Itô integral. At α=1\alpha=1, K≡1K\equiv1 and B~1/2=B\widetilde{B}^{1/2}=B.

Affine Volterra Models

We consider a class of affine Volterra models with diffusion and jump innovations ([3, 6]):

Xt=X0+∫0tK(t−s)∘{μ(Xs) ds+σ(Xs) dBs+dJs},(5)X_t = X_0 + \int_0^t \mathcal{K}(t-s) \circ\{\mu(X_s)\,\mathrm{d}s + \sigma(X_s)\,\mathrm{d}B_s + \mathrm{d}J_s\}, \tag*{(5)}

where XX is a predictable dd-dimensional process with locally integrable paths, X0X_0 is deterministic, BB is an mm-dimensional Brownian motion, K=(K1,…,Kd)⊤\mathcal{K} = (K_1,\ldots,K_d)^\top consists of deterministic, locally square-integrable kernels, and ∘\circ denotes componentwise multiplication. Here JJ is a compensated jump process whose jumps have conditional intensity λy(Xs)\lambda^y(X_s) and sizes distributed as a random vector y∈Rdy \in\mathbb{R}^d with a fixed, state-independent law satisfying EQ[∥y∥2]<∞\mathbb{E}^{\mathbb{Q}}[\lVert y\rVert^2] < \infty; its compensator subtracts λy(Xs)EQ[y] ds\lambda^y(X_s)\mathbb{E}^{\mathbb{Q}}[y]\,\mathrm{d}s from the uncompensated jump increments. For singular kernels, Equation (5) is understood to hold Q⊗dt\mathbb{Q} \otimes\mathrm{d}t-almost everywhere ([6]).

The drift, diffusion covariance and jump intensity are affine on the state space:

μ(x)=b0+∑k=1dbkxk,σ(x)σ(x)⊤=H0+∑k=1dHkxk,λy(x)=λ0y+∑k=1dλkyxk,(6)\mu(x) = b_0 + \sum_{k=1}^{d} b_kx_k,\quad\sigma(x)\sigma(x)^\top= H_0 + \sum_{k=1}^{d} H_kx_k,\quad\lambda^y(x) = \lambda^y_0 + \sum_{k=1}^{d}\lambda^y_kx_k, \tag*{(6)}

where bk∈Rdb_k \in\mathbb{R}^d, each Hk∈Rd×dH_k \in\mathbb{R}^{d \times d} is symmetric, and λky∈R\lambda^y_k \in\mathbb{R} for k=0,…,dk = 0,\ldots,d. We assume that the diffusion covariance is positive semidefinite and the jump intensity is nonnegative on the state space. Taking Ki≡1K_i \equiv1 for every component recovers an affine jump-diffusion, while setting λy≡0\lambda^y \equiv0 gives the diffusion setting of Abi Jaber et al. [3].

Whenever the expectation is absolutely convergent, write ϱ(z)=EQ[ez⊤y]\varrho(z) = \mathbb{E}^{\mathbb{Q}}[e^{z^\top y}] and define the affine cumulant functions by

Rk(z)=bk⊤z+12z⊤Hkz+λky[ϱ(z)−1−z⊤EQ[y]],k=0,…,d.(7)R_k(z) = b_k^\top z + \frac{1}{2}z^\top H_kz + \lambda^y_k\left[\varrho(z) - 1 - z^\top\mathbb{E}^{\mathbb{Q}}[y]\right],\quad k = 0,\ldots,d. \tag*{(7)}

For a horizon T>0T > 0 and transform argument u∈Cdu \in\mathbb{C}^d, the associated Riccati–Volterra equation is

Ψ(t,u)=u∘K(t)+∫0tK(t−s)∘R(Ψ(s,u)) ds,0<t≤T,(8)\Psi(t,u) = u \circ\mathcal{K}(t) + \int_0^t \mathcal{K}(t-s) \circ R(\Psi(s,u))\,\mathrm{d}s,\quad0 < t \le T, \tag*{(8)}

where R(z)=(R1(z),…,Rd(z))⊤R(z) = (R_1(z),\ldots,R_d(z))^\top.

Under suitable integrability and martingale conditions, solutions of Equation (8) yield initial-time exponential-affine transforms; see Abi Jaber et al. [3] and Bondi et al. [6]. The functions R1,…,RdR_1,\ldots,R_d determine the Riccati–Volterra equation, whereas R0R_0 enters only the state-independent part of the transform exponent. At later valuation times, conditional transforms generally depend on the past through an adjusted forward curve rather than on XtX_t alone ([3, 6]).

Framework

In this section, we propose a rough ISVIX (RISVIX) model and derive the corresponding VIX term structure and VIX option pricing formulas. Throughout the theoretical analysis, time zero denotes the valuation origin.

Model Specification

We extend the ISVIX framework of Luo et al. [23] using the fractional kernel K(t)=tα−1/Γ(α)K(t) = t^{\alpha-1}/\Gamma(\alpha) introduced in Subsection 2.2. Fix a finite horizon T>0T > 0. Under the risk-neutral measure Q\mathbb{Q}, the RISVIX model is

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