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Inferring volatility dynamics and risk premia from the S&P 500 and VIX markets

Chris Bardgett, Elise Gourier and Markus Leippold

Journal of Financial Economics, 2019, vol. 131, issue 3, 593-618

Abstract: We estimate a flexible affine model using an unbalanced panel containing S&P 500 and VIX index returns and option prices and analyze the contribution of VIX options to the model’s in- and out-of-sample performance. We find that they contain valuable information on the risk-neutral conditional distributions of volatility at different time horizons, which is not spanned by the S&P 500 market. This information allows enhanced estimation of the variance risk premium. We gain new insights on the term structure of the variance risk premium, present a trading strategy exploiting these insights, and show how to improve S&P 500 return forecasts.

Keywords: S&P 500 and VIX joint modeling; Volatility dynamics; Particle filter; Variance risk premium (search for similar items in EconPapers)
JEL-codes: G12 G13 C58 (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:jfinec:v:131:y:2019:i:3:p:593-618