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

See all articles by Fabian Hollstein

Fabian Hollstein

Leibniz University Hannover - School of Economics and Management

Marcel Prokopczuk

Leibniz Universit├Ąt Hannover - Faculty of Economics and Management; University of Reading - ICMA Centre

Date Written: June 26, 2017

Abstract

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

Hollstein, Fabian and Prokopczuk, Marcel, How Aggregate Volatility-of-Volatility Affects Stock Returns (June 26, 2017). Review of Asset Pricing Studies, Vol. 8, No. 2, 2018, Available at SSRN: https://ssrn.com/abstract=2990905

Fabian Hollstein (Contact Author)

Leibniz University Hannover - School of Economics and Management ( email )

Koenigsworther Platz 1
Hannover, 30167
Germany

Marcel Prokopczuk

Leibniz Universit├Ąt Hannover - Faculty of Economics and Management ( email )

Koenigsworther Platz 1
Hannover, 30167
Germany

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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