Variance Discount Rates: What Drives Preferences over Variance Risk?

64 Pages Posted: 22 Jan 2021

See all articles by Joren Koëter

Joren Koëter

Department of Finance; Tilburg University - Center for Economic Research (CentER)

Date Written: November 12, 2020

Abstract

I study time-variation in variance discount rates, defined as the expected returns for investing in variance risk. I show that variance discount rates drive a significant fraction of the variation in prices of S&P 500 variance swaps. This analysis offers important insights into preferences of investors over variance risk. I decompose variation in prices into variation due to variance expectations and variation due to variance discount rates. Variance expectations drive most of the variation in short-term variance swaps, whereas variance discount rates drive most of the variation in long-term variance swaps. I show that prominent asset pricing models, in which variation in the equity premium originates from variation in variance risk, have profoundly different predictions regarding the behavior of variance discount rates. None of the models analyzed are able to match the empirical properties of variance discount rates.

Keywords: asset pricing, derivatives, variance pricing, variance discount rates

JEL Classification: G12, G13

Suggested Citation

Koëter, Joren, Variance Discount Rates: What Drives Preferences over Variance Risk? (November 12, 2020). Available at SSRN: https://ssrn.com/abstract=3728730 or http://dx.doi.org/10.2139/ssrn.3728730

Joren Koëter (Contact Author)

Department of Finance; Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
65
Abstract Views
249
rank
402,434
PlumX Metrics