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Bad volatility is not always bad: evidence from the commodity markets

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  • Ivan Indriawan
  • Donald Lien
  • Tai-Yong Roh
  • Yahua Xu

Abstract

Using exchange-traded fund (ETF) options data, we examine the predictive power of variance risk premium on returns of four commodities: crude oil, natural gas, gold and silver. We also analyze the predictive power of upside and downside variance risk premiums using a decomposition model conditional on the direction of the underlying market movement. We find that both the undecomposed and decomposed variance risk premiums are able to predict commodity prices. The decomposed variance risk premiums, however, outperform the undecomposed premium. The importance of upside and downside variance risk premiums differs across markets, related to hedging demand. In energy markets, both upside and downside premiums have strong predictive power, while in precious metal markets, only the upside premium is predictive.

Suggested Citation

  • Ivan Indriawan & Donald Lien & Tai-Yong Roh & Yahua Xu, 2020. "Bad volatility is not always bad: evidence from the commodity markets," Applied Economics, Taylor & Francis Journals, vol. 52(40), pages 4384-4402, August.
    • Handle: RePEc:taf:applec:v:52:y:2020:i:40:p:4384-4402
    DOI: 10.1080/00036846.2020.1735619
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    Cited by:

    1. Naeem, Muhammad Abubakr & Peng, Zhe & Bouri, Elie & Hussain Shahzad, Syed Jawad & Karim, Sitara, 2022. "Examining the asymmetries between equity and commodity ETFs during COVID-19," Resources Policy, Elsevier, vol. 79(C).
    2. Wong, Patrick, 2023. "Explaining intraday crude oil returns with higher order risk-neutral moments," Journal of Commodity Markets, Elsevier, vol. 31(C).

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