Essays on Volatility and Variance Risk Premium PDF Download

Author: Xiaoman Su
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description

Author: Aoxiang Yang (Ph.D.)
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

View

Book Description
My dissertation is developed to address unresolved issues in the asset pricing literature, focusing on both risk premium levels and dynamics. Chapter 1 addresses short-horizon risk premium dynamics. In the data, stock market volatility weakly or even negatively predicts short-run equity and variance risk premia, challenging positive risk-return trade-offs at the heart of leading asset pricing models. I show that a puzzling negative volatility-risk premia relationship concentrates in scattered high-uncertainty states, which occur about 20\% of the time. While at other times, the relationship is strongly positive. I develop a micro-founded learning model in which due to learning frictions investors underreact to structural breaks in high-volatility periods and overreact to transitory variance shocks in normal times. The model can successfully explain the novel time-varying volatility-risk premia relationship at short and long horizons. The model can further account for many other data features, such as a robust positive correlation between equity and variance risk premium, the leverage effect, and negative observations of equity and variance risk premia at the onsets of recessions. Chapter 2, coauthored with Professor Bjorn Eraker, focuse on equilibrium derivatives pricing. It is motivated by the observation that leading asset pricing models typically can not explain the levels or dynamics of VIX options prices. We develop a tractable equilibrium pricing model to explain observed characteristics in equity returns, VIX futures, S\&P 500 options, and VIX options data based on affine jump-diffusive state dynamics and representative agents endowed with Duffie-Epstein recursive preferences. A specific model aimed at capturing VIX options prices and other asset market data is shown to successfully replicate the salient features of consumption, dividends, and asset market data, including the first two moments of VIX futures returns, the average implied volatilities in SPX and VIX options, and first and higher-order moments of VIX options returns. In the data, we document a time variation in the shape of VIX option implied volatility and a time-varying hedging relationship between VIX and SPX options which our model both captures. Our model also matches many other asset pricing moments such as equity premia, variance risk premia, risk-free interest rates, and short-horizon return predictability. To derive our specific model, we first develop a general framework for pricing assets under recursive Duffie-Epstein preferences with IES set to one under the assumption that state variables follow affine jump diffusions, as in \citet{DPS00}. Relative to the literature, our framework has a clear marginal contribution that it is an endowment-based equilibrium model with (i) clearly stated affine state variable dynamics and (ii) precisely characterized equilibrium value function, risk-free rate, prices of risks, and risk-neutral state dynamics. We prove our state-price density is a precise $IES\to1$ limit of that approximately solved in \citet{ErakShal08}. The recursive preference assumption implies that higher-order conditional moments of the economic fundamental, such as its growth volatility and volatility-of-volatility, are explicitly priced in equilibrium. Since VIX derivatives depend on these factors, this in turn implies that the former carry non-zero risk premia.

Author: Mathieu Fournier
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description

Author: Igor Pozdeev
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

View

Book Description
Variance risk premium is arguably one of the most important and robust risk premia documented in the academic finance. The first chapter of this thesis deals with variance risk on the FX market: therein, I recover risk-neutralized covariance matrices of currency returns and combine them with ex post realized covariance matrices to determine the sign of the premium, associate portfolios ranked from highest to lowest premium values with popular currency factors, study the determinants of the FX variance risk and its explore asset pricing properties. I find evidence for an overall negative FX variance risk premium, but also document existence of strategies with a significantly positive one. Among portfolios with the most negative premium estimates, the US dollar index and Carry trade familiarly emerge. I report that portfolios of negative spot return momentum and high recently realized variance exhibit more negative FX variance risk premium. As far as the asset pricing properties are concerned, the Carry trade variance risk dominates the US dollar variance risk as a priced factor, contributing to resolution of the differential pricing of "good and bad'' carry portfolios. The second chapter studies the dynamics of currency spot and excess returns before policy rate announcements of central banks in developed economies. Therein, Dmitry Borisenko and I show that currencies depreciate before target rate cuts and appreciate before rate hikes. What makes the finding surprising is the fact that the fixed income derivatives market allows to forecast monetary policy decisions accurately enough to make the above drift exploitable by investors: our baseline specification of the trading strategy constructed by going long and short currencies before predicted local rate hikes and cuts earns a significant average return which would be only marginally higher if the forecast quality were perfect. In the third chapter, Nikola Mirkov, Paul Söderl

Author: William N. Goetzmann
Publisher: Oxford University Press
ISBN: 0195148142
Category : Business & Economics
Languages : en
Pages : 568

View

Book Description
This book aims to create a strong understanding of the empirical basis for the equity risk premium. Through the research and anaylsis of two scholars who are experts in this field, this volume presents the key issues that are paramount to investors, including whether or not to use historical data as a method of equity investing, and can the equity premium reflect changes in fundamental values and cash flows of the market.

Author: Ke Chen (Economist)
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description
This thesis studies a few different finance topics on the application and modelling of jump and stochastic volatility process. First, the thesis proposed a non-parametric method to estimate the impact of jump dependence, which is important for portfolio selection problem. Comparing with existing literature, the new approach requires much less restricted assumption on the jump process, and estimation results suggest that the economical significance of jumps is largely mis-estimated in portfolio optimization problem. Second, this thesis investigates the time varying variance risk premium, in a framework of stochastic volatility with stochastic jump intensity. The proposed model considers jump intensity as an extra factor which is driven by realized jumps, in addition to a stochastic volatility model. The results provide strong evidence of multiple factors in the market and show how they drive the variance risk premium. Thirdly, the thesis uses the proposed models to price options on equity and VIX consistently. Based on calibrated model parameters, the thesis shows how to calculate the unconditional correlation of VIX future between different maturities.

Author: Fei Fang
Publisher:
ISBN:
Category :
Languages : en
Pages :

View

Book Description
This dissertation focuses on empirical asset pricing, including stock and options pricing. In the first and third chapter, we examine the linkage between stock market and options market at firm level. In Chapter Two, we documents the impact that systematic variance risk has for option prices of individual stocks. In the first chapter, we study the relation between future stock returns and option-based measures. We find that the options-based measure - future stock return relation is strongest for relatively less liquid stocks. After taking transaction costs into consideration, the risk-adjusted returns of the long-short stock portfolios do not differ significantly between stock liquidity groups. This chapter provides better understanding on the options-based stock return predictability. In the second chapter, we construct novel factors to mimic variance risk related to firm characteristics using individual stocks' variance risk premium. We then document that market variance risk premium and variance risk mimicking factors have strong explanatory power for option prices. Our new analytic framework links the variance risk factors related to firm characteristics to the individual equity option price structure. In the third chapter, we provide additional empirical results on how stock price can affect option prices. Our preliminary results reveal a link between the informational inefficiency of stock price and option prices. We find that a greater departure from random walk leads to a lower level of implied volatility (compared to realized volatility) and a steeper implied volatility curve.

Author:
Publisher:
ISBN:
Category :
Languages : en
Pages : 131

View

Book Description
My dissertation studies the asset pricing implications of non-linear models, including regime-switching models and non-linear diffusion models. The first chapter investigates empirically the effects of regime switches in stock returns and volatilities. First, the empirical results suggest that the expected excess return and the volatility are the monotonically increasing functions of the investors' belief. It implies that risk aversion is time-varying and the representative agent is more risk averse in the bear regime so that higher expected excess return and higher volatility are generated in the bear regime. The empirical work also finds that the term spread, the inflation rate, and the T-bill rate have significant business cycle patterns in the predictive regressions. For example, the term spread is positively related to the stock market returns in the bull regime, but is negatively related to the stock market returns in the bear regime. This suggests that the increasing term spread is a good news in the bad regime because it indicates that the economy is improving and will recover soon, thus the investors require a lower equity premium. In the second chapter, an econometric method is developed for pricing and estimation for a newclass of non-linear diffusion processes. These type of non-linear diffusion processes are used to model the dynamics of the VIX index under both the objective measure and the risk-neutral measure, where the latter is estimated from futures prices. The difference between the drifts under the objective measure and the risk-neutral measure is defined as a measure of the variance risk premium. The predictive regressions demonstrate that the variance risk premium estimated by the non-linear diffusion models has stronger predictive power for stock returns than the affine models. In the third chapter, a hidden Markov model is used to describe the dynamics of the realized variance of stock market returns. I investigate the relations among the variance regime, variance risk premium, and stock market returns. I find that the variance risk premium, i.e., the difference between the expected return variation under the risk-neutral and the physical measures, is higher in the high-variance regime, in which the volatility-of-volatility is high. However, the positive relation between the variance risk premium and future stock returns is entirely due to a component of variance risk premium that is orthogonal to the current realized variance and the variance regime. The results suggest that the predictive power of the variance risk premium for stock returns is more likely due to its correlation with time-varying risk aversion than with time-varying risks.

Author: Ralf Büsser
Publisher:
ISBN:
Category :
Languages : en
Pages : 0

View

Book Description
This dissertation comprises three parts. Each part has been set up as a self-contained research project and deals with a specific aspect of foreign exchange option markets. Part I examines the accuracy of option-implied density forecasts in predicting future realizations of the spot rate. To produce density forecasts, a range of interpolation techniques is used, among them a novel method that dynamically updates the information content of currency options. We observe that the risk-neutral density generally provides a biased estimate of the physical return distribution. This finding is robust to different choices of information sets. In Part I, we further establish empirically a link between forecasting accuracy and surrogates for variance and jump risk. Part II examines the variance risk premiums in foreign exchange markets using a model-free approach. When realized variance is computed from intraday data with low frequency, variance risk premiums are significantly negative. In contrast, estimates based on high-frequency data provide a somewhat different picture. This latter finding is likely owed to microstructure effects. Further investigations suggest that variance risk premiums are essentially unexplained by classic risk factors or fear of jump risk. However, we find a significant relationship between the success of a variance swap strategy and the VIX, the TED spread and the shape of the implied volatility function. Overall, we conclude that foreign exchange markets feature a separately priced variance risk factor with time-varying risk premium. In Part III, the structure of currency returns is examined at the case of two unspanned information sets, namely the prices for vanilla and one-touch options. A variety of models with increasing complexity is calibrated to the vanilla market and subsequently applied to quotes for one-touch options. This approach allows to draw conclusions on the coherence between the two markets a.

Author: Hamed Ghanbari
Publisher:
ISBN:
Category :
Languages : en
Pages : 179

View

Book Description
The first essay investigates the option-implied investor preferences by comparing equilibrium option pricing models under jump-diffusion to option bounds extracted from discrete-time stochastic dominance (SD). We show that the bounds converge to two prices that define an interval comparable to the observed option bid-ask spreads for S&P 500 index options. Further, the bounds' implied distributions exhibit tail risk comparable to that of the return data and thus shed light on the dark matter of the divergence between option-implied and underlying tail risks. Moreover, the bounds can better accommodate reasonable values of the ex-dividend expected excess return than the equilibrium models' prices. We examine the relative risk aversion coefficients compatible with the boundary distributions extracted from index return data. We find that the SD-restricted range of admissible RRA values is consistent with the macro-finance studies of the equity premium puzzle and with several anomalous results that have appeared in earlier option market studies.The second essay examines theoretically and empirically a two-factor stochastic volatility model. We adopt an affine two-factor stochastic volatility model, where aggregate market volatility is decomposed into two independent factors; a persistent factor and a transient factor. We introduce a pricing kernel that links the physical and risk neutral distributions, where investor's equity risk preference is distinguished from her variance risk preference. Using simultaneous data from the S&P 500 index and options markets, we find a consistent set of parameters that characterizes the index dynamics under physical and risk-neutral distributions. We show that the proposed decomposition of variance factors can be characterized by a different persistence and different sensitivity of the variance factors to the volatility shocks. We obtain negative prices for both variance factors, implying that investors are willing to pay for insurance against increases in volatility risk, even if those increases have little persistence. We also obtain negative correlations between shocks to the market returns and each volatility factor, where correlation is less significant in transient factor and therefore has a less significant effect on the index skewness. Our empirical results indicate that unlike stochastic volatility model, join restrictions do not lead to the poor performance of two-factor SV model, measured by Vega-weighted root mean squared errors.In the third essay, we develop a closed-form equity option valuation model where equity returns are related to market returns with two distinct systematic components; one of which captures transient variations in returns and the other one captures persistent variations in returns. Our proposed factor structure and closed-form option pricing equations yield separate expressions for the exposure of equity options to both volatility components and overall market returns. These expressions allow a portfolio manager to hedge her portfolio's exposure to the underlying risk factors. In cross-sectional analysis our model predicts that firms with higher transient beta have a steeper term structure of implied volatility and a steeper implied volatility moneyness slope. Our model also predicts that variances risk premiums have more significant effect on the equity option skew when the transient beta is higher. On the empirical front, for the firms listed on the Dow Jones index, our model provides a good fit to the observed equity option prices.