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Explaining the negative returns to volatility claims: An equilibrium approach

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  • Eraker, Bjørn
  • Wu, Yue

Abstract

We study the returns to investing in VIX futures, VIX Exchange Traded Notes (ETNs), and variance swaps. We document substantial negative return premia for these assets. For example, the constant maturity portfolio of 1-month VIX futures loses about 30% per year over our sample period (2006–2013). We investigate if these findings are consistent with dynamic equilibrium. We derive a model based on present value computation that endogenizes stock prices, the VIX index, and its associated derivative contracts. The model explains the negative return premia as well as several other stylized features of the VIX futures, ETNs, and variance swap data.

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  • Eraker, Bjørn & Wu, Yue, 2017. "Explaining the negative returns to volatility claims: An equilibrium approach," Journal of Financial Economics, Elsevier, vol. 125(1), pages 72-98.
    • Handle: RePEc:eee:jfinec:v:125:y:2017:i:1:p:72-98
    DOI: 10.1016/j.jfineco.2017.04.007
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    Cited by:

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    2. Ruan, Xinfeng & Zhang, Jin E., 2021. "The economics of the financial market for volatility trading," Journal of Financial Markets, Elsevier, vol. 52(C).
    3. Sarwar, Ghulam, 2020. "Interrelations in market fears of U.S. and European equity markets," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    4. Christensen, Kim & Christiansen, Charlotte & Posselt, Anders M., 2020. "The economic value of VIX ETPs," Journal of Empirical Finance, Elsevier, vol. 58(C), pages 121-138.
    5. Hongfei Tang & Xiaoqing Eleanor Xu, 2019. "Dissecting the tracking performance of regular and leveraged VIX ETPs," Review of Derivatives Research, Springer, vol. 22(2), pages 261-327, July.
    6. Lorraine Muguto & Paul-Francois Muzindutsi, 2022. "A Comparative Analysis of the Nature of Stock Return Volatility in BRICS and G7 Markets," JRFM, MDPI, vol. 15(2), pages 1-27, February.
    7. Sanjay K. Nawalkha & Xiaoyang Zhuo, 2022. "A Theory of Equivalent Expectation Measures for Contingent Claim Returns," Journal of Finance, American Finance Association, vol. 77(5), pages 2853-2906, October.
    8. Nawalkha, Sanjay K & Zhuo, Xiaoyang, 2020. "A Theory of Equivalent Expectation Measures for Expected Prices of Contingent Claims," OSF Preprints hsxtu, Center for Open Science.
    9. Chun, Dohyun & Cho, Hoon & Ryu, Doojin, 2023. "Discovering the drivers of stock market volatility in a data-rich world," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 82(C).
    10. Peter Van Tassel, 2018. "Equity Volatility Term Premia," Staff Reports 867, Federal Reserve Bank of New York.
    11. Taylor, Nick, 2019. "Forecasting returns in the VIX futures market," International Journal of Forecasting, Elsevier, vol. 35(4), pages 1193-1210.
    12. Naji Jalkh & Elie Bouri & Xuan Vinh Vo & Anupam Dutta, 2021. "Hedging the risk of travel and leisure stocks: The role of crude oil," Tourism Economics, , vol. 27(7), pages 1337-1356, November.
    13. Jonathan Dark & Xin Gao & Thijs van der Heijden & Federico Nardari, 2022. "Forecasting variance swap payoffs," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(12), pages 2135-2164, December.
    14. Xinglin Yang & Ji Chen, 2021. "VIX term structure: The role of jump propagation risks," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(6), pages 785-810, June.
    15. Mehmet F. Dicle, 2019. "Increasing return response to changes in risk," Review of Financial Economics, John Wiley & Sons, vol. 37(1), pages 197-215, January.
    16. Chun, Dohyun & Cho, Hoon & Ryu, Doojin, 2019. "Forecasting the KOSPI200 spot volatility using various volatility measures," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 514(C), pages 156-166.
    17. Mehmet F. Dicle & Kendra Reed, 2019. "Asymmetric return response to expected risk: policy implications," Journal of Financial Regulation and Compliance, Emerald Group Publishing Limited, vol. 27(3), pages 345-356, June.
    18. Sanjay K. Nawalkha & Xiaoyang Zhuo, 2020. "A Theory of Equivalent Expectation Measures for Contingent Claim Returns," Papers 2006.15312, arXiv.org, revised May 2022.
    19. Jungah Yoon & Xinfeng Ruan & Jin E. Zhang, 2022. "VIX option‐implied volatility slope and VIX futures returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(6), pages 1002-1038, June.
    20. Ruan, Xinfeng & Zhang, Jin E., 2021. "Time-varying uncertainty and variance risk premium," Journal of Macroeconomics, Elsevier, vol. 69(C).
    21. Karamfil Todorov, 2021. "Passive funds affect prices: evidence from the most ETF-dominated asset classes," BIS Working Papers 952, Bank for International Settlements.
    22. George O. Aragon & Rajnish Mehra & Sunil Wahal, 2018. "Do Properly Anticipated Prices Fluctuate Randomly? Evidence from VIX Futures Markets," NBER Working Papers 24575, National Bureau of Economic Research, Inc.
    23. Ruan, Xinfeng & Zhang, Jin E., 2018. "Equilibrium variance risk premium in a cost-free production economy," Journal of Economic Dynamics and Control, Elsevier, vol. 96(C), pages 42-60.

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    More about this item

    Keywords

    Variance risk premium; VIX futures; VIX ETN; Dynamic equilibrium; Jump-diffusion;
    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
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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