Bad Volatility is Not Always Bad: Evidence from Commodity Markets
46 Pages Posted: 2 Jul 2018
Date Written: June 19, 2018
Using four commodity exchange-traded fund (ETF) options data sets, we systematically examine the return predictability of the variance risk premiums in commodity markets. We also analyze the predictability of upside and downside variance risk premiums by performing a conditional decomposition based on the direction in which the market moves. We find that both the total and decomposed variance risk premiums contain predicative information about commodity prices, and the decomposed variance risk premiums jointly outperform the uncomposed premium. The importance of the downside (upside) variance risk premium differs across markets; in energy commodity markets, both upside and downside variance risk premiums have significant predictive power; in precious metal commodity markets, only the upside variance risk premium is predicative.
Keywords: Commodity markets; Upside and downside variance risk premiums; Asymmetric risk; Prediction
JEL Classification: G1; C5; Q3; Q4
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