Volatility Dispersion Trading

44 Pages Posted: 8 Jul 2008  

Qian Deng

University of Illinois at Urbana-Champaign

Date Written: Jan 25, 2008

Abstract

This papers studies an options trading strategy known as dispersion strategy to investigate the apparent risk premium for bearing correlation risk in the options market. Previous studies have attributed the profits to dispersion trading to the correlation risk premium embedded in index options. The natural alternative hypothesis argues that the profitability results from option market inefficiency. Institutional changes in the options market in late 1999 and 2000 provide a natural experiment to distinguish between these hypotheses. This provides evidence supporting the market inefficiency hypothesis and against the risk-based hypothesis since a fundamental market risk premium should not change as the market structure changes.

Keywords: volatility, dispersion trading, market inefficiency

JEL Classification: G10

Suggested Citation

Deng, Qian, Volatility Dispersion Trading (Jan 25, 2008). Available at SSRN: https://ssrn.com/abstract=1156620 or http://dx.doi.org/10.2139/ssrn.1156620

Qian Deng (Contact Author)

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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