Credit Variance Risk Premiums
48 Pages Posted: 24 Jun 2019 Last revised: 18 Sep 2019
Date Written: September 8, 2019
This paper studies variance risk premiums in the credit market. Using a novel data set of swaptions quotes on the CDX North America Investment Grade index, we find that returns of credit variance swaps are negative and economically large. Shorting credit variance swaps yields an annualized Sharpe ratio eclipsing its counterpart in fixed income or equity markets. The returns remain highly statistically significant when accounting for transaction costs, cannot be explained by established risk-factors, and hold for various investment horizons. We also dissect the overall variance risk premium into payer and receiver variance risk premiums. We find that exposure to both parts is priced. However, the returns for payer variance, associated with bad economic states, are roughly twice as high in absolute terms.
Keywords: Variance risk premium, CDS implied volatility, CDS variance swap
JEL Classification: G12, G13
Suggested Citation: Suggested Citation