Delta-Hedged Gains and the Negative Market Volatility Risk Premium

48 Pages Posted: 17 Apr 2001

See all articles by Nikunj Kapadia

Nikunj Kapadia

University of Massachusetts Amherst - Department of Finance

Gurdip Bakshi

Fox School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: April 9, 2001

Abstract

We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility risk premium and the mean delta-hedged portfolio returns. Using a sample of S&P 500 index options, we provide empirical tests that have the following general results. First, the delta-hedged strategy underperforms zero. Second, the documented underperformance is less for options away from the money. Third, the underperformance is greater at times of higher volatility. Fourth, the volatility risk premium significantly affects delta-hedged gains even after accounting for jump-fears. Our evidence is supportive of a negative market volatility risk premium.

Suggested Citation

Kapadia, Nikunj and Bakshi, Gurdip S., Delta-Hedged Gains and the Negative Market Volatility Risk Premium (April 9, 2001). AFA 2001 New Orleans Meetings. Available at SSRN: https://ssrn.com/abstract=267106 or http://dx.doi.org/10.2139/ssrn.267106

Nikunj Kapadia (Contact Author)

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States
413-545-5643 (Phone)
413-545-5600 (Fax)

HOME PAGE: http://www-unix.oit.umass.edu/~nkapadia/

Gurdip S. Bakshi

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

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