The Volatility-of-Volatility Term Structure
80 Pages Posted: 8 Jun 2017 Last revised: 21 Oct 2017
Date Written: October 19, 2017
This paper investigates the volatility-of-volatility (VVIX) term structure. The term structure is in nearly all cases downward sloping. We find that the slope of the VVIX (SlopeVVIX), defined as VVIX' second principal component, predicts excess returns of S\&P500 and VIX straddles. Its informational content is incremental to the VIX term structure and to the variance risk premium. To analyze which type of risk is captured by SlopeVVIX, we develop an affine approximation for the VVIX based on a VIX option pricing model. We find that the contributions of continuous vol-of-vol and jump risk to the term structure vary systematically with the state of the economy. When the latest major crises hit, continuous vol-of-vol took the lion's share over all maturities. As its relative contribution is similarly high across all maturities at these times, our results suggest that investors expected a prolonged period of high uncertainty in volatility.
Keywords: Financial Crises, Option Returns, Term Structure, Volatility, Volatility-of-Volatility, VVIX
JEL Classification: C13, G01, G12, G13, G17
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