Volatility Disagreement and Asset Prices

48 Pages Posted: 29 Nov 2023 Last revised: 9 May 2024

See all articles by Adem Atmaz

Adem Atmaz

Purdue University - Daniels School of Business

Andrea M Buffa

University of Colorado at Boulder - Leeds School of Business

Date Written: November 6, 2023

Abstract

We study a dynamic equilibrium model in which investors disagree on future volatility and trade volatility derivatives to hedge stock positions and speculate. On average, volatility disagreement makes the variance risk premium more negative. However, volatility trading enables a risk transfer among investors that turns the variance risk premium positive when the market underestimates future volatility. Under higher volatility, investors trade fewer volatility derivatives as these become too risky. These economic mechanisms shed light on empirical regularities during market turmoil. Volatility disagreement also lowers the stock market valuation, increases market volatility, and generates time-variation in the leverage effect.

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 Asset Prices (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 - Daniels School of Business ( email )

403 Mitch Daniels Blvd
West Lafayette, IN 47907

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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