Bad Volatility Is Not Always Bad: Evidence from the Commodity Markets

45 Pages Posted: 10 Jul 2019

See all articles by Ivan Indriawan

Ivan Indriawan

Auckland University of Technology - Department of Finance

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Tai-Yong Roh

Liaoning University

Yahua Xu

Central University of Finance and Economics (CUFE) - China Economics and Management Academy

Date Written: July 8, 2019

Abstract

Using exchange-traded fund (ETF) options data, we examine return predictability of variance risk premium in four commodity markets: crude oil, natural gas, gold and silver. We also analyze return predictability of upside and downside variance risk premiums using a decomposition model conditional on the direction of the underlying market movement. We find that both the undecomposed and decomposed variance risk premiums are able to predict commodity prices. The decomposed variance risk premiums, however, outperform the undecomposed premium. The importance of upside and downside variance risk premiums differs across markets, related to hedging demand. In energy markets, both upside and downside premiums have strong predictive power, while in precious metal markets, only the upside premium is predictive.

Keywords: Commodity markets; Upside and downside variance risk premiums; Asymmetric risk; Prediction

JEL Classification: C53; G11; G14; G17

Suggested Citation

Indriawan, Ivan and Lien, Donald and Roh, Tai-Yong and Xu, Yahua, Bad Volatility Is Not Always Bad: Evidence from the Commodity Markets (July 8, 2019). Available at SSRN: https://ssrn.com/abstract=3416414 or http://dx.doi.org/10.2139/ssrn.3416414

Ivan Indriawan

Auckland University of Technology - Department of Finance ( email )

AUT City Campus
Private Bag 92006
Auckland, 1142
New Zealand

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Tai-Yong Roh

Liaoning University ( email )

Shenyang, Liaoning
China

Yahua Xu (Contact Author)

Central University of Finance and Economics (CUFE) - China Economics and Management Academy ( email )

NO.39 South College Road
Haidian District
Beijing, 100081
China

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