The Skew Risk Premium in the Equity Index Market

Review of Financial Studies (2013), 26, 2174-2203

AFA 2011 Denver Meetings Paper

34 Pages Posted: 18 Mar 2010 Last revised: 4 Oct 2014

Roman Kozhan

University of Warwick, Warwick Business School

Anthony Neuberger

Cass Business School, City, University of London

Paul Schneider

University of Lugano - Institute of Finance; Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: November 27, 2012

Abstract

We measure the skew risk premium in the equity index market through the skew swap. We argue that just as variance swaps can be used to explore the relationship between the implied variance in option prices and realized variance, so too can skew swaps be used to explore the relationship between the skew in implied volatility and realized skew. Like the variance swap, the skew swap corresponds to a trading strategy, necessary to assess risk premia in a model-free way. We find that almost half of the implied volatility skew can be explained by the skew risk premium. We provide evidence that skew and variance premia are manifestations of the same underlying risk factor in the sense that strategies designed to exploit one of the risk premia but to hedge out the other make zero excess returns.

Keywords: skew risk premium, variance risk premium, index options

JEL Classification: G10, G12, G13

Suggested Citation

Kozhan, Roman and Neuberger, Anthony and Schneider, Paul, The Skew Risk Premium in the Equity Index Market (November 27, 2012). Review of Financial Studies (2013), 26, 2174-2203; AFA 2011 Denver Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1571700 or http://dx.doi.org/10.2139/ssrn.1571700

Roman Kozhan

University of Warwick, Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Anthony Neuberger

Cass Business School, City, University of London ( email )

London, EC2Y 8HB
Great Britain

Paul Georg Schneider (Contact Author)

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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