How Does the Market Variance Risk Premium Vary Over Time? Evidence from S&P 500 Variance Swap Investment Returns PDF Download
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Author: Eirini Konstantinidi
Publisher:
ISBN:
Category :
Languages : en
Pages : 43
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Book Description
We explore whether the market variance risk premium (VRP) can be predicted. We measure VRP by distinguishing the investment horizon from the variance swap's maturity. We extract VRP from actual S&P 500 variance swap quotes and we test four classes of predictive models. We find that the best performing model is the one that conditions on trading activity. This relation is also economically significant. Volatility trading strategies which condition on trading activity outperform popular benchmark strategies, even once we consider transaction costs. Our finding implies that broker dealers command a greater VRP to continue holding short positions in index options in the case where trading conditions deteriorate.
Author: Eirini Konstantinidi
Publisher:
ISBN:
Category :
Languages : en
Pages : 43
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Book Description
We explore whether the market variance risk premium (VRP) can be predicted. We measure VRP by distinguishing the investment horizon from the variance swap's maturity. We extract VRP from actual S&P 500 variance swap quotes and we test four classes of predictive models. We find that the best performing model is the one that conditions on trading activity. This relation is also economically significant. Volatility trading strategies which condition on trading activity outperform popular benchmark strategies, even once we consider transaction costs. Our finding implies that broker dealers command a greater VRP to continue holding short positions in index options in the case where trading conditions deteriorate.
Author: Grigory Vilkov
Publisher:
ISBN:
Category :
Languages : en
Pages : 32
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Book Description
We study the dynamics and cross-sectional properties of the variance risk premia embedded in options on stocks and indices, approximated by the synthetic variance swap returns. Several important stylized facts and contributions arise. First, variance risk premia for indices are systematically larger (more negative) than for individual securities. Second, there are systematic cross-sectional differences in the price of variance in individual stocks. Linking variance swaps to firm size/book-to-market, and stock turnover characteristics, an investor gains access to several lucrative long-short strategies with Sharpe Ratios around 2.85. Third, principal component analysis reveals at most one important factor driving both stock and variance swap returns, which corresponds to the traditional market factor. For the remainder of the dynamics, the stock and its variance processes are nearly linearly independent. Fourth, we find the leverage effect through analysis of the relationship between the variance risk premium and stock to variance correlation. The systematic (market factor) part of the leverage effect provides additional evidence of the existence of one factor common to both variance swaps and stocks, but the contribution of the market risk premium to the total variance premium is very small. These findings stress the importance of using variance-based instruments in the portfolio of an investor.
Author: José Da Fonseca
Publisher:
ISBN:
Category :
Languages : en
Pages : 30
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Book Description
We extract variance and skew risk premiums from volatility derivatives in a model-free way and analyze their relationships along with volatility index and equity index returns. These risk premiums can be synthesized through option trading strategies. Using a time series of option prices on the VIX, the most liquid volatility derivative market, we find that variance swap excess return can be partially explained by volatility index and equity index excess returns while these latter variables carry little information for the skew swap excess return. The results sharply contrast with those obtained for the equity index option market underlining very specific characteristics of the volatility derivative market.
Author: Markus Leippold
Publisher:
ISBN:
Category :
Languages : en
Pages : 60
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Book Description
With increasing appreciation of the fact that stock return variance is stochastic and variance risk is heavily priced, the industry has created a series of variance derivative products to span variance risk. The variance swap contract is the most actively traded of these products. It pays at expiry the difference between the realized return variance and a fixed rate, called the variance swap rate, determined at the inception of the contract. We obtain a decade worth of variance swap rate quotes at five maturities. With the data, we first exploit the information in both the time series and the term structure of the variance swap rates to analyze the return variance rate dynamics and market pricing of variance risk. We then study both theoretically and empirically how investors can use variance swap contracts across different maturities to span the variance risk and to revise their dynamic asset allocation decisions. We find that with the swap contract to span the variance risk, an investor increases her investment in the underlying stock.In addition, the investor's indirect utility increases significantly when allowed to span the volatility risk using variance swap contracts. Finally, an out-of-sample study confirms that the gains from including variance swaps into the portfolio mix are large.
Author: Liuren Wu
Publisher:
ISBN:
Category :
Languages : en
Pages : 43
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Book Description
With a portfolio of options on Samp;P 500 index, the Chicago Board of Options Exchange constructs a volatility index named VIX that approximates the 30-day return variance swap rate on the index. Using high-frequency return data, researchers have proposed various return quadratic variation estimators. This paper estimates the index return variance dynamics and variance risk premium jointly from the VIX index and various quadratic variation estimators constructed from tick data on Samp;P 500 index futures. Estimation shows that the index return variance jumps. The jump arrival rate is not constant over time, but proportional to the variance rate level. Furthermore, jumps in the index return variance are not rare events, but arrive frequently and generate sample paths that show infinite variation. Estimation also identifies a strongly negative variance risk premium, the absolute magnitude of which is proportional to the variance rate level. Finally, the estimation highlights the importance and necessity for removing microstructure noise in estimating quadratic variations.
Author: Maximilian Neumann
Publisher:
ISBN:
Category :
Languages : en
Pages : 39
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Book Description
We analyze the risk premia embedded in the S&P 500 spot index and option markets. We use a long time-series of spot prices and a large panel of option prices to jointly estimate the diffusive stock risk premium, the Price jump risk premium, the diffusive variance risk premium and the variance jump risk premium. The risk premia are statistically and economically significant and move over time. Investigating the economic drivers of the risk premia, we are able to explain up to 63% of these variations.
Author: Bruno Feunou
Publisher:
ISBN:
Category : Capital market
Languages : en
Pages : 36
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Book Description
Author: Junye Li
Publisher:
ISBN:
Category :
Languages : en
Pages : 39
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Book Description
This paper examines the properties of the variance risk premium (VRP). We propose a flexible asset pricing model that captures co-jumps in prices and volatility, and self-exciting jump clustering. We estimate the model on equity returns and variance swap rates at different horizons. The total VRP is negative and has a downward-sloping term structure, while its jump component displays an upward-sloping term structure. The abrupt and persistent response of the short-term jump VRP to extreme events makes this specific premium a proxy for investors' fear of a market crash. Furthermore, the use of the VRP level and slope, and of its components, helps improve the short-run predictability of equity excess returns.
Author: Ke Chen (Economist)
Publisher:
ISBN:
Category : Risk-return relationships
Languages : en
Pages : 100
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Book Description
Author: Bala Arshanapalli
Publisher:
ISBN:
Category :
Languages : en
Pages : 48
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Book Description
This paper investigates the sources of time-varying risk and risk premia for both the U.S. stock and bond markets. Although a growing literature has emerged that examines the return and volatility characteristics of the U.S. stock and bond markets separately, little work has appeared that models these markets jointly. This paper proposes a model that provides evidence concerning the sources of time varying risk and risk premia in the markets that considers both markets simultaneously. The model captures the change in the risk premium to each market's own volatility risk as well as to the covariance risk for specific events. We test for the effects of macroeconomic news on time-varying volatility as well as time-varying covariance, and whether such news induces time-varying risk premia in either of the markets. We find that stocks, as opposed to bonds exhibit a change in the risk premium on variance risk on PPI announcement dates. There is also evidence of a change in the bond risk premium on covariance risk on macroeconomic news announcement dates. Employment reports and PPI releases appear as events inducing time-varying conditional variance for stock, Treasury Notes, as well as Treasury Bond returns. Finally, the results do not support the conjecture that conditional covariance of stock and bond returns falls on announcement days.
