Variance Risk Premia

Peter Carr and Liuren Wu ()
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Peter Carr: New York University & Bloomberg

Finance from EconWPA

Abstract: We propose a direct and robust method for quantifying the variance risk premium on financial assets. We theoretically and numerically show that the risk-neutral expected value of the return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. Ignoring the small approximation error, the difference between the realized variance and this synthetic variance swap rate quantifies the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premia on five stock indexes and 35 individual stocks.

Keywords: Stochastic volatility; variance risk premia; variance swap; volatility swap; option pricing; expectation hypothesis (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 C51 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
Date: Written 2004-09-07
Note: Type of Document - pdf; pages: 60
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http://129.3.20.41/eps/fin/papers/0409/0409015.pdf (application/pdf)

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