The Market Price of Risk of the Variance Term Structure

44 Pages Posted: 9 Sep 2009 Last revised: 26 Apr 2011

See all articles by George Dotsis

George Dotsis

National Kapodistrian University of Athens - Faculty of Economics; Essex Finance Centre, Essex Business School, University of Essex

Date Written: April 5, 2011

Abstract

In this paper I examine the market price of risk of the variance term structure. To this end, the S&P 500 VIX variance term structure is used as a proxy for aggregate variance risk. Principal component analysis shows that time variation in the variance term structure over the 1992-2009 period can be explained mainly by two factors, which capture changes in the level and slope. The market price of risk of each factor is estimated in the cross-section of asset returns. I find that both factors have a negative market price of risk. The most important factor in the cross-section is the slope which also predicts changes in market excess returns over annual horizons. A model with the market return and the two variance factors has similar performance to the Fama-French model in pricing size and book-to-market sorted portfolios.

Keywords: stochastic volatility, volatility term structure, cross-section of returns

JEL Classification: G10, G12

Suggested Citation

Dotsis, George, The Market Price of Risk of the Variance Term Structure (April 5, 2011). Available at SSRN: https://ssrn.com/abstract=1469585 or http://dx.doi.org/10.2139/ssrn.1469585

George Dotsis (Contact Author)

National Kapodistrian University of Athens - Faculty of Economics ( email )

Greece

HOME PAGE: http://sites.google.com/site/gdotsis/

Essex Finance Centre, Essex Business School, University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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