65 Pages Posted: 19 Sep 2014 Last revised: 19 Feb 2018
Date Written: February 14, 2018
We show that time-varying volatility of volatility is a significant risk factor which affects the cross-section and the time-series of index and VIX option returns, beyond volatility risk itself. Volatility and volatility-of-volatility measures, identified model-free from options data as the VIX and VVIX indices, respectively, are only weakly related to each other. Delta-hedged index and VIX option returns are negative on average, and more negative for strategies more exposed to volatility and volatility-of-volatility risks. Volatility and volatility of volatility significantly and negatively predict future delta-hedged option payoffs. The evidence is consistent with a no-arbitrage model featuring time-varying volatility and volatility-of-volatility factors, which are negatively priced by investors.
Keywords: volatility, volatility of volatility, VIX, VVIX, options
JEL Classification: G12, G13, G17
Suggested Citation: Suggested Citation