Credit Variance Risk Premiums

Abstract

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 and High Yield
indices. The returns of credit variance swaps are negative and economically large,
irrespective of the credit rating class. They are robust to transaction costs and cannot
be explained by established risk factors and structural model variables. We also dissect
the overall variance risk premium into receiver and payer variance risk premiums. We
show that credit variance risk premiums are mainly driven by the payer corridor, which
is associated with worsening macroeconomic conditions.

Keywords: Variance risk premium, CDS implied volatility, CDS variance swap

JEL Classification: G12