Volatility-of-Volatility Risk

62 Pages Posted: 29 May 2018 Last revised: 4 Jun 2018

See all articles by Christian Schlag

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Ivan Shaliastovich

University of Wisconsin - Madison

Julian Thimme

Karlsruhe Institute of Technology

Darien Huang

Cornell University - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: May 2018

Abstract

We show that time-varying volatility of volatility is a significant risk factor which affects the cross-section and the time-series of index and VIX option returns, beyond volatility risk itself. Volatility and volatility-of-volatility measures, identified model-free from the option price data as the VIX and VVIX indices, respectively, are only weakly related to each other. Delta-hedged index and VIX option returns are negative on average, and are more negative for strategies which are more exposed to volatility and volatility-of-volatility risks. Volatility and volatility of volatility significantly and negatively predict future delta-hedged option payoffs. The evidence is consistent with a no-arbitrage model featuring time-varying market volatility and volatility-of-volatility factors, both of which have negative market price of risk.

Keywords: volatility of volatility, hedging errors, risk premiums

JEL Classification: G12, G13

Suggested Citation

Schlag, Christian and Shaliastovich, Ivan and Thimme, Julian and Huang, Darien, Volatility-of-Volatility Risk (May 2018). SAFE Working Paper No. 210. Available at SSRN: https://ssrn.com/abstract=3183610 or http://dx.doi.org/10.2139/ssrn.3183610

Christian Schlag (Contact Author)

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Julian Thimme

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

HOME PAGE: http://julianthimme.de

Darien Huang

Cornell University - Department of Finance ( email )

Ithaca, NY 14853-4201
United States

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