Unknown Unknowns: Vol-of-Vol and the Cross-Section of Stock Returns
Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)
Sjoerd Van Bekkum
Erasmus University Rotterdam - Finance Group; Tinbergen Institute
Bart Van der Grient
Robeco Asset Management - Quantitative Strategies
March 6, 2013
AFA 2013 San Diego Meetings Paper
We develop a measure for uncertainty about expected stock returns that is derived directly from the well-developed literature on second-order utility: the volatility of option-implied volatility (vol-of-vol). High vol-of-vol stocks signal more of such uncertainty, and robustly underperform low vol-of-vol stocks by 10 percent per year. The vol-of-vol effect is not driven by optimism bias or arbitrage frictions, exposures to jump risk or stochastic volatility risk, or by higher-order risk. Moreover, statistical tests cannot confirm that vol-of-vol is a priced risk factor in traditional asset pricing models. Our results seem inconsistent with rational pricing of uncertainty by a representative agent.
Number of Pages in PDF File: 69
Keywords: asset pricing, stock returns, uncertainty
JEL Classification: G10, G12, D80working papers series
Date posted: March 20, 2012 ; Last revised: March 15, 2013
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