Subjective Model Uncertainty, Variance Risk Premium, and Speculative Trading

54 Pages Posted: 30 Jun 2013 Last revised: 29 Jul 2019

See all articles by Ming Guo

Ming Guo

ShanghaiTech University; ShanghaiTech University - School of Entrepreneurship and Management

Hao Zhou

Tsinghua University - PBC School of Finance; SUSTech Business School

Multiple version iconThere are 2 versions of this paper

Date Written: August 1, 2018

Abstract

This paper develops a dynamic model of prices and trades in a risky security and an option, where agents use different subjective likelihood functions to interpret a public signal, but they are initially uncertain about the signal precision or mean. Our model can explain the seemingly overpriced options and endogenously generate variance risk premium (VRP). However, subjective model uncertainty about the signal precision (mean) implies that options and VRP are unspanned (spanned) and that trading volume is negatively (positively) related to VRP. Empirical evidence largely supports subjective model uncertainty about the signal precision in major futures markets.

Keywords: Subjective model uncertainty, signal precision or mean, option-implied uncertainty premium, variance risk premium, trading volume.

JEL Classification: G11, G12, G13

Suggested Citation

Guo, Ming and Guo, Ming and Zhou, Hao, Subjective Model Uncertainty, Variance Risk Premium, and Speculative Trading (August 1, 2018). Available at SSRN: https://ssrn.com/abstract=2286767 or http://dx.doi.org/10.2139/ssrn.2286767

Ming Guo

ShanghaiTech University ( email )

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Room 323 SEM
Shanghai, Shanghai 201210
China
86-21-2068-5452 (Phone)

ShanghaiTech University - School of Entrepreneurship and Management ( email )

100 Haike Rd
Pudong Xinqu, Shanghai
China

Hao Zhou (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
+86-10-62790655 (Phone)

SUSTech Business School ( email )

1088 Xueyuan Avenue, Nanshan District
Southern University of Science and Technology
Shenzhen, Guangdong 518055
China

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