Volatility-of-Volatility and Tail Risk Hedging Returns

50 Pages Posted: 22 Mar 2013 Last revised: 30 Sep 2015

See all articles by Yang-Ho Park

Yang-Ho Park

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: May 18, 2015

Abstract

This paper reports that the volatility-of-volatility implied by VIX options has predictability for tail risk hedging returns. Specifically, an increase in the volatility-of-volatility as measured by the VVIX index raises current prices of tail risk hedging options, such as S&P 500 puts and VIX calls, and lowers their subsequent returns over the next three to four weeks. The results are robust to jump risk, skewness, kurtosis, option liquidity, variance risk premium, and limit of arbitrage. The predictability can be explained by either risk premiums for a time-varying crash risk factor or uncertainty premiums for a time-varying uncertain belief in volatility.

Keywords: Volatility of volatility, tail risk, rare disaster, option returns, risk premiums, and VIX options

JEL Classification: G12, G13

Suggested Citation

Park, Yang-Ho, Volatility-of-Volatility and Tail Risk Hedging Returns (May 18, 2015). Journal of Financial Markets, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2236158 or http://dx.doi.org/10.2139/ssrn.2236158

Yang-Ho Park (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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