The Relation between Physical and Risk‐Neutral Cumulants

37 Pages Posted: 3 Sep 2013

See all articles by Huimin Zhao

Huimin Zhao

The University of Hong Kong

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance

Eric C. Chang

University of Hong Kong - School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: September 2013

Abstract

Variance swaps are natural instruments for investors taking directional bets on volatility and are often used for portfolio protection. The empirical observation on skewness research suggests that derivative professionals may also desire to hedge beyond volatility risk and there exists the need to hedge higher‐moment market risks, such as skewness and kurtosis risks. We study two derivative contracts – skewness swap and kurtosis swap – which trade the forward realized third and fourth cumulants. Using S&P 500 index options data from 1996 to 2005, we document the returns of these swap contracts, i.e., skewness risk premium and kurtosis risk premium. We find that the both skewness and kurtosis risk premiums are significantly negative.

Suggested Citation

Zhao, Huimin and Zhang, Jin E. and Chang, Eric Chieh C., The Relation between Physical and Risk‐Neutral Cumulants (September 2013). International Review of Finance, Vol. 13, Issue 3, pp. 345-381, 2013. Available at SSRN: https://ssrn.com/abstract=2319629 or http://dx.doi.org/10.1111/irfi.12013

Huimin Zhao

The University of Hong Kong ( email )

School of Business, HKU,
Pokfulam Road
Hong Kong, Hong Kong HK
China
22415685 (Phone)

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance ( email )

Dunedin, 9054
New Zealand
64 3 479 8575 (Phone)
64 3 479 8171 (Fax)

HOME PAGE: http://sites.google.com/site/jinzhanghomepage/home

Eric Chieh C. Chang

University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

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