Variance risk, financial intermediation, and the cross-section of expected option returns

Alexandre Ziegler and Schürhoff, Norman
Authors registered in the RePEc Author Service: Norman Schuerhoff

No 8268, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We explore the pricing of variance risk by decomposing stocks' total variance into systematic and idiosyncratic return variances. While systematic variance risk exhibits a negative price of risk, common shocks to the variances of idiosyncratic returns carry a large positive risk premium. This implies investors pay for insurance against increases (declines) in systematic (idiosyncratic) variance, even though both variances comove countercyclically. Common idiosyncratic variance risk is an important determinant for the cross-section of expected option returns. These findings reconcile several phenomena, including the pricing differences between index and stock options, the cross-sectional variation in stock option expensiveness, the volatility mispricing puzzle, and the significant returns earned on various option portfolio strategies. Our results are consistent with theories of financial intermediation under capital constraints.

Keywords: Asset pricing; Cross-section of option returns; Financial intermediation; Variance risk (search for similar items in EconPapers)
JEL-codes: G12 G13 G24 (search for similar items in EconPapers)
Date: 2011-02
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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