Why do rational investors like variance at the peak of a crisis? A learning-based explanation

Mohammad Ghaderi, Mete Kilic and Sang Byung Seo

Journal of Monetary Economics, 2024, vol. 142, issue C

Abstract: Investors’ learning can drastically alter the dynamics of the variance risk premium: it no longer increases as economic conditions deteriorate but exhibits a highly nonlinear pattern, occasionally even turning negative. We demonstrate this intuition using a model where investors rationally form their belief about the hidden economic state. When the “bad” state becomes probable, investors start liking high future variance because it overwhelmingly correlates with lower marginal utility. This mechanism rationalizes the puzzling observation that risk-neutral volatility falls short of physical volatility at the peak of a severe crisis. Our results shed light on the interpretation of good economic uncertainty.

Keywords: Negative variance risk premium; Bayesian learning; Rational investors; Good uncertainty; Crisis dynamics (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304393223001009
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:142:y:2024:i:c:s0304393223001009

DOI: 10.1016/j.jmoneco.2023.08.006

Access Statistics for this article

Journal of Monetary Economics is currently edited by R. G. King and C. I. Plosser

More articles in Journal of Monetary Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().