Variance Risk Premiums in Foreign Exchange Markets

Manuel Ammann and Ralf Buesser

No 1304, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: Based on the theory of static replication of variance swaps we assess the sign and magnitude of variance risk premiums in foreign exchange markets. We find significantly negative risk premiums when realized variance is computed from intraday data with low frequency. As a likely consequence of microstructure effects however, the evidence is ambiguous when realized variance is based on high-frequency data. Common to all estimates, variance risk premiums are highly time-varying and inversely related to the risk-neutral expectation of future variance. When we test whether variance risk premiums can be attributed to classic risk factors or fear of jump risk, we find that conditional premiums remain significantly negative. However, we observe a strong relationship between the size of log variance risk premiums and the VIX, the TED spread and the general shape of the implied volatility function of the corresponding currency pair. Overall, we conclude that there is a separately priced variance risk factor which commands a highly time-varying premium.

Keywords: Foreign exchange; variance risk premium; variance swap; intraday data; risk- neutral expectation; jump risk. (search for similar items in EconPapers)
JEL-codes: C12 C13 F31 G12 G13 G15 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2013-04
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

Downloads: (external link)
http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1304.pdf (application/pdf)

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:usg:sfwpfi:2013:04

Access Statistics for this paper

More papers in Working Papers on Finance from University of St. Gallen, School of Finance Contact information at EDIRC.
Bibliographic data for series maintained by (sof@unisg.ch).