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Variance Risk Premiums

Peter Carr1,2,3; Liuren Wu4

1 Bloomberg (United States) · 2 Courant Institute of Mathematical Sciences · 3 New York University · 4 Baruch College

Review of Financial Studies 2009

We propose a direct and robust method for quantifying the variance risk premium on financial assets. We show that the risk-neutral expected value of return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. We propose to use the difference between the realized variance and this synthetic variance swap rate to quantify the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premiums on five stock indexes and 35 individual stocks. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: [email protected], Oxford University Press.

DOI
10.1093/rfs/hhn038
Volume
22 (3)
Pages
1311-1341
Language
en
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