Abstract

http://ssrn.com/abstract=1734781
 
 

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What is the Equilibrium Price of Variance Risk? A Long-Run Risks Model with Two Volatility Factors


Nicole Branger


University of Muenster - Finance Center Muenster

Clemens Völkert


University of Muenster - Finance Center Muenster

September 9, 2012


Abstract:     
This paper explores how economic uncertainty evolves over time and how it is priced in the market. We solve for the variance premium, the prices of equity index options, and the prices of volatility related derivatives in a long-run risks model. We find that both short-run and long-run uncertainty factors are necessary to explain the empirical characteristics of variance risk while remaining consistent with consumption and asset pricing data. The variance premium is mainly driven by the risk of a sudden increase in the overall level of uncertainty. Out-of-the-money equity index put options and out-of-the-money call options on variance provide insurance against market crashes. Consistent with the data, these contracts are priced at a premium.

Number of Pages in PDF File: 48

Keywords: long-run risks, variance premium, volatility derivatives

JEL Classification: G12, G13

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Date posted: February 1, 2012 ; Last revised: February 21, 2013

Suggested Citation

Branger, Nicole and Völkert, Clemens, What is the Equilibrium Price of Variance Risk? A Long-Run Risks Model with Two Volatility Factors (September 9, 2012). Available at SSRN: http://ssrn.com/abstract=1734781 or http://dx.doi.org/10.2139/ssrn.1734781

Contact Information

Nicole Branger
University of Muenster - Finance Center Muenster ( email )
Universitatsstr. 14-16
Muenster, 48143
Germany
+49 251 83 22033 (Phone)
+49 251 83 22690 (Fax)
HOME PAGE: http://www.wiwi.uni-muenster.de/fcm/derivatives/organisation/details.php?weobjectID=162
Clemens Völkert (Contact Author)
University of Muenster - Finance Center Muenster ( email )
Universitätsstr. 14-16
Münster, 48143
Germany
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