The Volatility Premium

Bjorn Eraker ()
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Bjorn Eraker: Wisconsin School of Business, University of Wisconsin-Madison, USA

Quarterly Journal of Finance (QJF), 2021, vol. 11, issue 03, 1-35

Abstract: The difference, average risk-neutral and physical volatility, is substantial and translates into a large return premium for sellers of index options. This paper studies a general equilibrium model based on long-run risk in an effort to explain the premium. In estimating the model using data on stock returns and volatility (VIX), the model captures the premium and also the large negative correlation between shocks to volatility and stock prices. Numerical simulations verify that writers of index options earn high rates of return in equilibrium and that the return patterns are similar to that seen in the S&P 500 index options data.

Keywords: Option pricing; volatility risk premium; option returns (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (4)

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DOI: 10.1142/S2010139221500142

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