Volatility Disagreement and Equilibrium Volatility Trading

51 Pages Posted: 29 Nov 2023

See all articles by Adem Atmaz

Adem Atmaz

Purdue University - Krannert School of Management

Andrea M Buffa

University of Colorado at Boulder - Leeds School of Business

Date Written: November 6, 2023

Abstract

We develop a dynamic equilibrium model in which investors disagree on future volatility and trade volatility derivatives to hedge their stock positions and speculate on their beliefs. We find that in equilibrium investors trade less volatility derivatives in more volatile periods, and they may also do so when they disagree more. The variance risk premium is negative on average, but it becomes positive when the market tends to underestimate future volatility. Volatility disagreement generates time-variation in the leverage effect, which gets stronger in more volatile periods, consistent with empirical evidence. Our framework, which can also incorporate an aggregate volatility bias, reconciles other key aspects of volatility derivatives and stock markets in a unified setting.

Keywords: Volatility disagreement, volatility trading, volatility derivatives market, variance swaps, variance risk premium, leverage effect, equilibrium asset prices

JEL Classification: G11, G12, G13, D53

Suggested Citation

Atmaz, Adem and Buffa, Andrea M, Volatility Disagreement and Equilibrium Volatility Trading (November 6, 2023). Available at SSRN: https://ssrn.com/abstract=4624158 or http://dx.doi.org/10.2139/ssrn.4624158

Adem Atmaz (Contact Author)

Purdue University - Krannert School of Management ( email )

403 West State Street
West Lafayette, IN 47907
United States

HOME PAGE: http://www.aatmaz.com

Andrea M Buffa

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

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