The Price of Variance Risk
74 Pages Posted: 26 Jul 2014 Last revised: 9 Oct 2015
Date Written: April 29, 2015
In the period 1996-2014, the average investor in the variance swap market was indifferent to news about future variance at horizons ranging from 1 month to 14 years. It is only purely transitory and unexpected realized variance that were priced. These results present a challenge to most structural models of the variance risk premium, such as the intertemporal CAPM, recent models with Epstein-Zin preferences and long-run risks, and models where institutional investors have value-at-risk constraints. The results also have strong implications for macro models where volatility affects investment decisions, suggesting that investors are not willing to pay to hedge shocks in expected economic uncertainty.
Keywords: variance swaps, volatility pricing, VIX, asset pricing, disasters
JEL Classification: G12
Suggested Citation: Suggested Citation