Variance trading and market price of variance risk

Oleg Bondarenko

Journal of Econometrics, 2014, vol. 180, issue 1, 81-97

Abstract: This paper develops a new approach for variance trading. We show that the discretely-sampled realized variance can be robustly replicated under very general conditions, including when the price can jump. The replication strategy specifies the exact timing for rebalancing in the underlying. The deviations from the optimal schedule can lead to surprisingly large hedging errors. In the empirical application, we synthesize the prices of the variance contract on S&P 500 index over the period from 01/1990 to 12/2009. We find that the market variance risk is priced, its risk premium is negative and economically very large. The variance risk premium cannot be explained by the known risk factors and option returns.

Keywords: Variance risk; Option valuation; Risk-neutral density; Stochastic volatility (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:180:y:2014:i:1:p:81-97

DOI: 10.1016/j.jeconom.2014.02.001

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