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The Price of the Smile and Variance Risk Premia

Peter H. Gruber, Claudio Tebaldi () and Fabio Trojani ()
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Peter H. Gruber: University of Lugano

No 15-36, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: In a tractable stochastic volatility model, we identify the price of the smile as the price of the unspanned risks traded in SPX option markets. The price of the smile reflects two persistent volatility and skewness risks, which imply a downward sloping term structure of low-frequency variance risk premia in normal times. In periods of distress, the term structure is upward sloping and dominated by a high-frequency premium for jump variance. This dichotomy is consistent with the puzzling skew sensitivities of option markets with credit-constrained intermediaries and it builds a challenge for many reduced-form and structural models of stochastic volatility.

Keywords: Price of the Smile; Price of Volatility; Option Pricing; Stochastic Volatility; Unspanned Skewness; Financial Constrains; Financial Intermediation; Financial Crisis; Factor Models; Matrix Jump Diffusions; Variance Swaps; Skew Swaps (search for similar items in EconPapers)
JEL-codes: G10 G12 G13 (search for similar items in EconPapers)
Pages: 70 pages
Date: 2015-09
New Economics Papers: this item is included in nep-fmk and nep-rmg
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