Does variance risk have two prices? Evidence from the equity and option markets

Abstract

BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org).

The Term Structure of the Price of Variance Risk

“…Cheng documents that hedging is cheaper during turbulent times, whereas we find that the price of variance risk is more negative and that its term structure is steeper when current volatility is high. Barras and Malkhozov (2015) find differences in estimates of variance risk premia in the equity and option markets that are driven by institutional factors. While this finding suggests a potential explanation for the differences between our results and those of Dew-Becker et al (2014) as well as those of Cheng (2014), it also emphasizes the value of using different methodological approaches and different data sets to approach an academic understanding of the market for volatility risk.…”

Interrelations of U.S. market fears and emerging markets returns: Global evidence

“…Bekaert and Hoerova (2014) show that VIX has two components, namely, stock market uncertainty (conditional or realized variance of stock returns) and variance risk premium (expected premium for selling stock market variance in the swap market). Barras and Malkhozov (2016) show strong relations between U.S. macrofinance variables and VIX's variance risk premium. They report that variance premium predicts U.S. stock returns whereas the conditional variance predicts economic activity; both components also predict financial instability.…”

“…Bekaert, Hoerova, and Lo Duca (2013) document strong interactions between the U.S. monetary policy and variance risk premium component of VIX. Barras and Malkhozov (2016) show strong relations between U.S. macrofinance variables and VIX's variance risk premium. Similarly, Bakshi, Panayotov, and Skoulakis (2016) and Luo and Zhang (2017) show that forward variances constructed from VIX are predictive of U. S. real economic activity and stock market returns.…”

Variance disparity and market frictions

“…However, their ability to hedge nonzero derivative positions can be impaired by limited capital. Recently, Barras and Malkhozov (2016) and Fournier and Jacobs (2016) find evidence that market makers' risk bearing capacity affects their willingness to provide liquidity in option markets and, thus, option prices. In addition, arbitrageurs are also subject to limited capital because a margin is required for any arbitrage position in futures and options markets.…”