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Variance Risk Premia
Peter Carr New York University - Courant Institute of Mathematical Sciences; Bloomberg Financial Markets (BFM) Liuren Wu City University of New York, CUNY Baruch College - Zicklin School of Business October 24, 2007 AFA 2005 Philadelphia Meetings Abstract: We propose a direct and robust method for quantifying the variance risk premium on financial assets. We theoretically and numerically show that the risk-neutral expected value of the return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. Ignoring the small approximation error, the difference between the realized variance and this synthetic variance swap rate quantifies the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premia on five stock indexes and 35 individual stocks.
Keywords: Stochastic volatility, variance risk premia, variance swap, volatility swap, option pricing, expectation hypothesis JEL Classifications: G10, G12, G13, C51 Working Paper SeriesDate posted: August 17, 2004 ; Last revised: October 25, 2007Suggested CitationContact Information
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