Volatility-of-Volatility and Tail Risk Hedging Returns
50 Pages Posted: 22 Mar 2013 Last revised: 30 Sep 2015
Date Written: May 18, 2015
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: Suggested Citation