Volatility-of-volatility risk

Darien Huang, Christian Schlag, Ivan Shaliastovich and Julian Thimme

No 210, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: We show that time-varying volatility of volatility is a significant risk factor which affects the cross-section and the time-series of index and VIX option returns, beyond volatility risk itself. Volatility and volatility-of-volatility measures, identified modelfree from the option price data as the VIX and VVIX indices, respectively, are only weakly related to each other. Delta-hedged index and VIX option returns are negative on average, and are more negative for strategies which are more exposed to volatility and volatility-of-volatility risks. Volatility and volatility of volatility significantly and negatively predict future delta-hedged option payoffs. The evidence is consistent with a no-arbitrage model featuring time-varying market volatility and volatility-of-volatility factors, both of which have negative market price of risk.

Keywords: volatility of volatility; hedging errors; risk premiums (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-fmk, nep-knm and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:210

DOI: 10.2139/ssrn.3183610

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