Variance Term Structure and VIX Futures Pricing

Abstract

Using no arbitrage principle, we derive a relationship between the drift term of risk-neutral dynamics for instantaneous variance and the term structure of forward variance curve. We show that the forward variance curve can be derived from options market. Based on the variance term structure, we derive a no arbitrage pricing model for VIX futures pricing. The model is the first no arbitrage model combining options market and VIX futures market. The model can be easily generalized to price other volatility derivatives.