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The price of variance risk

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

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.

Suggested Citation

  • Dew-Becker, Ian & Giglio, Stefano & Le, Anh & Rodriguez, Marius, 2017. "The price of variance risk," Journal of Financial Economics, Elsevier, vol. 123(2), pages 225-250.
    • Handle: RePEc:eee:jfinec:v:123:y:2017:i:2:p:225-250
    DOI: 10.1016/j.jfineco.2016.04.003
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    More about this item

    Keywords

    Variance risk premium; Recursive preferences; Disasters;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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