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Variance Risk Premiums

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  • Peter Carr
  • Liuren Wu

Abstract

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.

Suggested Citation

  • Peter Carr & Liuren Wu, 2009. "Variance Risk Premiums," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1311-1341.
  • Handle: RePEc:oup:rfinst:v:22:y:2009:i:3:p:1311-1341.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhn038
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