Excess Volatility: Beyond Discount Rates
70 Pages Posted: 6 Mar 2015 Last revised: 30 Jul 2019
Date Written: January 17, 2017
We document a form of excess volatility that is difficult to reconcile with standard models of prices, even after accounting for variation in discount rates. We compare prices of claims on the same cash flow stream but with different maturities. Standard models impose precise internal consistency conditions on the joint behavior of long and short maturity claims and these are strongly rejected in the data. In particular, long maturity prices are significantly more variable than justified by the behavior at short maturities. Our findings are pervasive. We reject internal consistency conditions in all term structures that we study, including equity options, currency options, credit default swaps, commodity futures, variance swaps, and inflation swaps.
Keywords: excess volatility, discount rates, term structure
JEL Classification: G10, G02
Suggested Citation: Suggested Citation