What Does the Volatility Risk Premium Say About Liquidity Provision and Demand for Hedging Tail Risk?

Fan, Jianqing; Imerman, Michael B.; Dai, Wei

doi:10.2139/ssrn.2234438

Cited by 8 publications

(5 citation statements)

References 56 publications

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“…We calculate RV t of month t by using m daily S&P 500 closing prices. Fan et al (2013) state that a negative VRP reflects the amount that market participants would like to pay to hedge volatility risk. As a consequence, in times of market stress and increasing tail risk, the VRP should become positive.…”

Section: Variance Risk Premiummentioning

confidence: 99%

What drives tail risk in aggregate European equity markets?

Kinateder

2015

The Journal of Risk Finance

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Purpose – The paper aims to analyse the drivers of changes in European equity tail risk. Design/methodology/approach – For this purpose, the paper uses a panel data model with fixed effects based on five explanatory variables including the VIX, the variance risk premium (VRP), the one-year lagged slope of the riskless term-structure, the default spread and market-specific illiquidity via the measure of Bao et al. (2011). The study analyses a comprehensive database of representative European equity indices from February 2003 to December 2013. The database just contains markets of euro member states to avoid biases due to different currencies. To measure equity tail risk, the ex post realized value-at-risk was used. Findings – There is empirical evidence that the VIX, the VRP and the default spread are key determinants of equity tail risk changes across all markets. Moreover, the results reveal that market-specific illiquidity is an important determinant in PIIGS markets and the one-year lagged term-structure slope in core markets. The analysis also documents that market-specific risk premia are a relevant determinant of equity tail risk changes. Another finding is that risk premia in PIIGS markets are basically higher as in core markets, which reflect the higher risk involved in investing in PIIGS markets. Originality/value – The paper offers a unique perspective on equity tail risk in aggregate equity markets and helps both investors and risk managers to get a comprehensive understanding of relevant drivers.

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Section: Variance Risk Premiummentioning

confidence: 99%

What drives tail risk in aggregate European equity markets?

Kinateder

2015

The Journal of Risk Finance

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“…The results for financial firms are typically similar in terms of statistical significance, but always stronger in terms of economic significance. Interestingly, for financial firms, we find a volatility feedback effect from the option market to the stock market (Fan et al, 2013or Bollerslev et al, 2014. The estimated coefficient of the impact of IV on stock return is equal to Ϫ2.7E-04, meaning that a 10 per cent increase in IV results in a slight decrease, on average Ϫ0.0027 per cent of the stock prices (or Ϫ0.7 per cent annualized) on the following day.…”

mentioning

confidence: 79%

The relative informational efficiency of stocks, options and credit default swaps during the financial crisis

Amadori

Bekkour

Lehnert

2014

The Journal of Risk Finance

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Purpose – This paper aims to investigate informational efficiency of stock, options and credit default swap (CDS) markets. Previous research suggests that informed traders prefer equity option and CDS markets over stock markets to exploit their informational advantage. As a result, equity and credit derivative markets contribute more to price discovery compared to stock markets. Design/methodology/approach – In this study, the authors investigate the dynamics behind informed investors’ trading decisions in European stock, options and CDS markets. This allows to identify the predictive explanatory power of the unique information contained in each market with respect to future stock, CDS and option market movements. Findings – A lead-lag relation is found between the CDS market and the other markets, in which changes in CDS spreads are able to consistently forecast changes in stock prices and equity options’ implied volatilities, indicating how the fast-growing CDS market seems to play a special role in the price discovery process. Moreover, in contrast to results of US studies, the stock market is found to forecast changes in the other two markets, suggesting that investors also prefer stock market involvement to exploit their information advantages before moving to CDS and option markets. Interestingly, these patterns have only emerged during the recent financial crisis, while before the crisis, the option market was found to be of major importance in the price discovery process. Originality/value – The authors are the first to study the lead-lag relationship among European stock, option and CDS markets for a large sample period covering the financial crisis.

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“…An advantage of working directly with variance swap payoffs, as e.g. in Fournier and Jacobs (2015) and Fan, Imerman, and Dai (2016), is that we can leave the model for…”

Section: Swap Payoff and Vrpmentioning

confidence: 99%

“…First, the variance swap payoff itself has been used as a proxy for the VRP, as e.g. in Carr and Wu (2009), Fournier and Jacobs (2015) and Fan, Imerman, and Dai (2016). Although this is a model free VRP estimate it does not constitute an ex-ante expectation as a risk premium should be.…”

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confidence: 99%

Variance swap payoffs, risk premia and extreme market conditions

Rombouts

Stentoft

Violante

2020

Econometrics and Statistics

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This paper estimates the Variance Risk Premium (VRP) directly from synthetic variance swap payoffs. Since variance swap payoffs are highly volatile, we extract the VRP by using signal extraction techniques based on a state-space representation of our model in combination with a simple economic constraint. Our approach, only requiring option implied volatilities and daily returns for the underlying, provides measurement error free estimates of the part of the VRP related to normal market conditions, and allows constructing variables indicating agents' expectations under extreme market conditions. The latter variables and the VRP generate different return predictability on the major US indices. A factor model is proposed to extract a market VRP which turns out to be priced when considering Fama and French portfolios.

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What Does the Volatility Risk Premium Say About Liquidity Provision and Demand for Hedging Tail Risk?

Cited by 8 publications

References 56 publications

What drives tail risk in aggregate European equity markets?

What drives tail risk in aggregate European equity markets?

The relative informational efficiency of stocks, options and credit default swaps during the financial crisis

Variance swap payoffs, risk premia and extreme market conditions

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