How Aggregate Volatility-of-Volatility Affects Stock Returns
Review of Asset Pricing Studies, Vol. 8, No. 2, 2018
Posted: 23 Jun 2017 Last revised: 1 May 2019
Date Written: June 26, 2017
A stylized theoretical model with stochastic volatility suggests the existence of a tradeoff between returns and volatility-of-volatility. Using the VVIX, a measure of the option-implied volatility of the volatility index, we confirm this prediction and detect that time-varying aggregate volatility-of-volatility commands an economically substantial and statistically significant negative risk premium. We find that a two-standard deviation increase in aggregate volatility-of-volatility factor loadings is associated with a decrease in average annual returns of about 11%. These results are robust to controlling for aggregate volatility, jump risk, and several other characteristics and factor sensitivities, as well as to various further tests.
Keywords: Aggregate economic uncertainty, stock market volatility-of-volatility, VVIX
JEL Classification: G12, G11
Suggested Citation: Suggested Citation