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Credit Variance Risk Premiums

Manuel Ammann () and Mathis Mörke ()
Authors registered in the RePEc Author Service: Mathis Moerke

No 1908, Working Papers on Finance from University of St. Gallen, School of Finance

Abstract: This paper studies variance risk premiums in the credit market. Using a novel data set of swaptions quotes on the CDX North America Investment Grade index, we find that returns of credit variance swaps are negative and economically large. Shorting variance swaps yields an annualized Sharpe ratio of almost six, eclipsing its counterpart in fixed income or equity markets. The returns remain highly statistically significant when accounting for transaction costs, cannot be explained by established risk-factors, and hold for various investment horizons. We also dissect the overall variance risk premium into payer and receiver variance risk premiums. We find that exposure to both parts is priced. However, the returns for payer variance, associated with bad economic states, are roughly twice as high in absolute terms.

Keywords: Variance risk premium; CDS implied volatility; CDS variance swap (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2019-06
New Economics Papers: this item is included in nep-fmk, nep-ore and nep-rmg
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