Abstract

http://ssrn.com/abstract=2348137
 


 



Resolution of Policy Uncertainty and Sudden Declines in Volatility


Dante Amengual


Centre for Monetary and Financial Studies (CEMFI)

Dacheng Xiu


University of Chicago - Booth School of Business

August 5, 2014

Chicago Booth Research Paper No. 13-78
Fama-Miller Working Paper

Abstract:     
We introduce downward volatility jumps into a general non-affine modeling framework of the term structure of variance. With variance swaps and S&P 500 returns, 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 the Federal Reserve chairman. We also find that such jumps are priced with positive risk premia, which reflect the price of the "put protection" offered by the Federal Reserve. Ignoring downward volatility jumps may lead to an exaggeration of the negative total variance risk premia, hence a biased-interpretation of the price of tail events. We also find variance risk premia tend to be insignificant or even positive at the inception of crises. On the modeling side, we explore the structural differences and relative goodness-of-fits of factor specifications, and find that the log-volatility model with two Ornstein-Uhlenbeck factors and double-sided jumps are superior in capturing volatility dynamics and pricing variance swaps.

Number of Pages in PDF File: 53

Keywords: Non-Affine Derivative Pricing Models, Log Volatility Models, Quadratic Volatility Models, Downward Volatility Jumps, Variance Swaps

JEL Classification: G12, G13

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Date posted: November 2, 2013 ; Last revised: August 6, 2014

Suggested Citation

Amengual, Dante and Xiu, Dacheng, Resolution of Policy Uncertainty and Sudden Declines in Volatility (August 5, 2014). Chicago Booth Research Paper No. 13-78; Fama-Miller Working Paper . Available at SSRN: http://ssrn.com/abstract=2348137 or http://dx.doi.org/10.2139/ssrn.2348137

Contact Information

Dante Amengual
Centre for Monetary and Financial Studies (CEMFI) ( email )
Casado del Alisal 5
28014 Madrid
Spain
Dacheng Xiu (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
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