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Journal of Banking & Finance Vol. 62 2016

How does the market variance risk premium vary over time? Evidence from S&P 500 variance swap investment returns

Eirini Konstantinidi1; George Skiadopoulos2,3,4

1 University of Manchester · 2 Queen Mary University of London · 3 University of Piraeus · 4 Piraeus Bank

Abstract

We explore whether the market variance risk premium (VRP) can be predicted. We measure VRP by distinguishing the investment horizon from the variance swap’s maturity. We extract VRP from actual S&P 500 variance swap quotes and we test four classes of predictive models. We find that the best performing model is the one that conditions on trading activity. This relation is also economically significant. Volatility trading strategies which condition on trading activity outperform popular benchmark strategies, even once we consider transaction costs. Our finding implies that broker dealers command a greater VRP to continue holding short positions in index options in the case where trading conditions deteriorate.

DOI
10.1016/j.jbankfin.2015.10.006
Volume
62
Pages
62-75
Language
en
Sources
crossref openalex bibtex:phds-export.bib

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