Abstract

https://ssrn.com/abstract=2348137
 


 



Resolution of Policy Uncertainty and Sudden Declines in Volatility


Dante Amengual


Centre for Monetary and Financial Studies (CEMFI)

Dacheng Xiu


University of Chicago - Booth School of Business

October 24, 2016

Chicago Booth Research Paper No. 13-78
Fama-Miller Working Paper

Abstract:     
We introduce downward volatility jumps into a general non-affine modeling framework of the term structure of variance. With variance swaps and S&P 500 returns, we find that downward volatility jumps are associated with a resolution of policy uncertainty, mostly through statements from FOMC meetings and speeches of the Fed chairman. We also find that such jumps are priced with positive risk premia, which reflect the price of the "put protection" offered by the Fed. Ignoring them may lead to an incorrect interpretation of such tail events. Moreover, variance risk premia tend to be insignificant or even positive at the inception of crises. On the modeling side, we explore the structural differences and relative goodness-of-fits of factor specifications, and find that the log-volatility model with two Ornstein-Uhlenbeck factors and double-sided jumps is superior in capturing volatility dynamics and pricing variance swaps, compared to the affine model prevalent in the literature or non-affine specifications without downward jumps.

Number of Pages in PDF File: 58

Keywords: Non-Affine Derivative Pricing Models, Log Volatility Models, Quadratic Volatility Models, Downward Volatility Jumps, Variance Swaps

JEL Classification: G12, G13


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Date posted: November 2, 2013 ; Last revised: February 13, 2017

Suggested Citation

Amengual, Dante and Xiu, Dacheng, Resolution of Policy Uncertainty and Sudden Declines in Volatility (October 24, 2016). Chicago Booth Research Paper No. 13-78; Fama-Miller Working Paper . Available at SSRN: https://ssrn.com/abstract=2348137 or http://dx.doi.org/10.2139/ssrn.2348137

Contact Information

Dante Amengual
Centre for Monetary and Financial Studies (CEMFI) ( email )
Casado del Alisal 5
28014 Madrid
Spain
Dacheng Xiu (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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