The price of variance risk

Ian Dew-Becker; Stefano Giglio; Anh Le; Marius Rodriguez

doi:10.1016/j.jfineco.2016.04.003

The price of variance risk

Ian Dew-Becker, Stefano Giglio, Anh Le, Marius Rodriguez

Finance

Research output: Contribution to journal › Article › peer-review

78 Scopus citations

Abstract

Between 1996 and 2014, it was costless on average to hedge news about future variance at horizons ranging from 1 quarter to 14 years. Only unexpected, transitory realized variance was significantly priced. These results present a challenge to many structural models of the variance risk premium, such as the intertemporal CAPM and recent models with Epstein–Zin preferences and long-run risks. The results are also difficult to reconcile with macro models in which volatility affects investment decisions. At the same time, the data allows us to distinguish between different disaster models; a model in which the stock market has a time-varying exposure to disasters and investors have power utility fits the major features of the variance term structure.

Original language	English (US)
Pages (from-to)	225-250
Number of pages	26
Journal	Journal of Financial Economics
Volume	123
Issue number	2
DOIs	https://doi.org/10.1016/j.jfineco.2016.04.003
State	Published - Feb 1 2017

All Science Journal Classification (ASJC) codes

Accounting
Finance
Economics and Econometrics
Strategy and Management

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10.1016/j.jfineco.2016.04.003

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abstract = "Between 1996 and 2014, it was costless on average to hedge news about future variance at horizons ranging from 1 quarter to 14 years. Only unexpected, transitory realized variance was significantly priced. These results present a challenge to many structural models of the variance risk premium, such as the intertemporal CAPM and recent models with Epstein–Zin preferences and long-run risks. The results are also difficult to reconcile with macro models in which volatility affects investment decisions. At the same time, the data allows us to distinguish between different disaster models; a model in which the stock market has a time-varying exposure to disasters and investors have power utility fits the major features of the variance term structure.",

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AB - Between 1996 and 2014, it was costless on average to hedge news about future variance at horizons ranging from 1 quarter to 14 years. Only unexpected, transitory realized variance was significantly priced. These results present a challenge to many structural models of the variance risk premium, such as the intertemporal CAPM and recent models with Epstein–Zin preferences and long-run risks. The results are also difficult to reconcile with macro models in which volatility affects investment decisions. At the same time, the data allows us to distinguish between different disaster models; a model in which the stock market has a time-varying exposure to disasters and investors have power utility fits the major features of the variance term structure.

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The price of variance risk

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