Term spreads of implied volatility smirk and variance risk premium

Wei Guo, Xinfeng Ruan, Sebastian A. Gehricke and Jin E. Zhang

Journal of Futures Markets, 2023, vol. 43, issue 7, 829-857

Abstract: In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in‐sample and out‐of‐sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.

Date: 2023
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