Variance Risk Premiums
Posted: 17 Mar 2009
Date Written: March 2009
We propose a direct and robust method for quantifying the variance risk premium on financial assets. We show that the risk-neutral expected value of return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. We propose to use the difference between the realized variance and this synthetic variance swap rate to quantify the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premiums on five stock indexes and 35 individual stocks.
Keywords: G10, G12, G13
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