Volatility-of-Volatility Risk in Asset Pricing
Review of Asset Pricing Studies, Forthcoming
74 Pages Posted: 27 Feb 2021 Last revised: 12 Jul 2021
Date Written: June 30, 2021
This paper develops a general equilibrium model and provides empirical support that the market volatility-of-volatility (VOV) predicts market returns and drives the time-varying volatility risk. In asset pricing tests with the market, volatility, and VOV as factors, the risk premium on VOV is statistically and economically significant and robust. Market and volatility risks are not priced in unconditional models, but, consistent with theory, their factor loadings, conditional on VOV, are priced. The pricing impact of VOV strengthens during market crashes, suggesting that VOV is particularly relevant during market turmoil, when investors demand increased compensation for VOV risk.
Keywords: Volatility-of-Volatility, Volatility Risk, Conditional Asset Pricing Model, Market Crashes
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation