When Uncertainty Blows in the Orchard: Comovement and Equilibrium Volatility Risk Premia

52 Pages Posted: 17 Feb 2009 Last revised: 16 Sep 2013

Andrea Buraschi

The University of Chicago; Imperial College Business School; Centre for Economic Policy Research (CEPR)

Fabio Trojani

University of Geneva; Swiss Finance Institute

Andrea Vedolin

London School of Economics and Political Science

Date Written: April 11, 2011

Abstract

We produce novel evidence for an equilibrium link between investors' disagreement, the market price of volatility and correlation, and the differential pricing of index and individual equity options. We show that belief disagreement is positively related to (i) the wedge between index and individual volatility risk premia, (ii) the different slope of the smile of index and individual options and (iii) the correlation risk premium. Priced disagreement risk also explains returns of option volatility and correlation trading strategies in a way that is robust to the inclusion of other risk factors and different market conditions.

Keywords: Disagreement, Correlation Risk Premium, Uncertainty, Volatility Risk Premium

JEL Classification: D80, G12, G13

Suggested Citation

Buraschi, Andrea and Trojani, Fabio and Vedolin, Andrea, When Uncertainty Blows in the Orchard: Comovement and Equilibrium Volatility Risk Premia (April 11, 2011). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1344368 or http://dx.doi.org/10.2139/ssrn.1344368

Andrea Buraschi

The University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
7738347123 (Phone)

HOME PAGE: http://www.andreaburaschi.com/

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.andreaburaschi.com/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Fabio Trojani

University of Geneva ( email )

Geneva
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Andrea Vedolin (Contact Author)

London School of Economics and Political Science ( email )

Department of Finance
Houghton Street
London, WC2A 2AE
United Kingdom

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