Resolution of Policy Uncertainty and Sudden Declines in Volatility
Centre for Monetary and Financial Studies (CEMFI)
University of Chicago - Booth School of Business
October 28, 2013
Chicago Booth Research Paper No. 13-78
Fama-Miller Working Paper
We introduce downward volatility jumps into a general framework of modeling the term structure of variance. With variance swap data alone, we find that downward volatility jumps are associated with a resolution of policy uncertainty, in particular through statements from Federal Open Market Committee meetings and speeches of Federal Reserve chairmen, and that such jumps are priced with positive risk premia, which reflect the premia for the "put protection" offered by the Federal Reserve. On the modeling side, we explore the structural differences and relative goodness-of-fits of factor specifications, and find that a log-volatility model with two Ornstein-Uhlenbeck factors and two-sided jumps is superior in capturing the volatility dynamics.
Number of Pages in PDF File: 59
Keywords: Quadratic Volatility Models, Log Volatility Models, Downward Volatility Jumps, Variance Swaps
JEL Classification: G12, G13working papers series
Date posted: November 2, 2013
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