Abstract
Abstract In this paper, we investigate a two‐factor VIX model with infinite‐activity jumps, which is a more realistic way to reduce errors in pricing VIX derivatives, compared with Mencía and Sentana (2013), J Financ Econ , 108 , 367–391. Our two‐factor model features central tendency, stochastic volatility and infinite‐activity pure jump Lévy processes which include the variance gamma (VG) and the normal inverse Gaussian (NIG) processes as special cases. We find empirical evidence that the model with infinite‐activity jumps is superior to the models with finite‐activity jumps, particularly in pricing VIX options. As a result, infinite‐activity jumps should not be ignored in pricing VIX derivatives.