Credit Variance Risk Premiums

48 Pages Posted: 24 Jun 2019 Last revised: 18 Sep 2019

See all articles by Manuel Ammann

Manuel Ammann

University of St. Gallen - School of Finance

Mathis Moerke

University of St. Gallen - Swiss Institute of Banking and Finance

Date Written: September 8, 2019

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 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

Ammann, Manuel and Moerke, Mathis, Credit Variance Risk Premiums (September 8, 2019). University of St.Gallen, School of Finance Research Paper No. 2019/08 . Available at SSRN: https://ssrn.com/abstract=3409082 or http://dx.doi.org/10.2139/ssrn.3409082

Manuel Ammann (Contact Author)

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

Mathis Moerke

University of St. Gallen - Swiss Institute of Banking and Finance ( email )

Rosenbergstrasse 52
St. Gallen, CH-9000
Switzerland

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