Do Different Measures of Stock Market Volatility Risk Have the Same Price?

Abstract

While other commonly used measures of aggregate stock market volatility are strongly priced in the cross-section of stock returns, the empirical evidence is considerably weaker for option implied market volatility. The differential pricing of market volatility risks is hard to reconcile with existing theories, but potentially consistent with partial segmentation between index options and equity markets. I argue the comovement between option implied and actual stock volatilities contains valuable information about time varying segmentation between equity and index options markets. The two markets appear to have become more integrated in recent years, partly due to decreases in option transaction costs.

Keywords: the pricing of volatility risk, realized volatility, option implied volatility, expected volatility, segmentation

JEL Classification: G12