The influence of tracking error on volatility risk premium estimation

James S. Doran

Journal of Risk

Abstract: ABSTRACT I investigate whether the volatility risk premium is negative in energy and equity markets by examining the statistical properties of delta–gamma hedged option portfolios (selling the option, hedging with the underlying contract, and correcting for tracking error with an additional option). By correcting for gamma, these hedged portfolios are not subject to the same discretization and model misspecification problems as traditional deltahedged portfolios. Within a stochastic volatility framework, I demonstrate that ignoring an option’s gamma can lead to incorrect inference on the magnitude of the volatility risk premium. Using a sample of S&P100 Index and natural gas contracts, empirical tests reveal that the delta–gamma hedged strategy outperforms zero and the degree of overperformance is proportional to the level of volatility.

References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.risk.net/journal-of-risk/2161025/the-i ... k-premium-estimation (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:rsk:journ4:2161025

Access Statistics for this article

More articles in Journal of Risk from Journal of Risk
Bibliographic data for series maintained by Thomas Paine ().