Volatility-of-Volatility Risk in the Crude Oil Market
33 Pages Posted: 31 Jul 2019 Last revised: 13 Mar 2020
Date Written: July 27, 2019
Under the stochastic volatility-of-volatility framework, we show that oil volatility-of-volatility risk is a significant pricing factor for cross-sectional delta-hedged gains constructed from 1-month United States Oil Fund (USO) options, and is negatively priced. Moreover, oil volatility-of-volatility risk can significantly and negatively predict one-period ahead delta-hedged option gains. The findings are robust after implementing several tests such as controlling for jump risk measures, another measure of oil volatility-of-volatility and delta-hedged gains constructed from 1-week USO options. The information content of oil volatility-of-volatility is also distinctive from its equity counterpart, which can contribute to predicting the future real personal consumption expenditure.
Keywords: Crude oil market; Stochastic volatility-of-volatility risk; Delta-hedged gains; Jump risks; Pricing implications
JEL Classification: G1; C5; Q3; Q4
Suggested Citation: Suggested Citation