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Volatility as an Asset Class: European Evidence


  • Reinhold Hafner
  • Martin Wallmeier


Volatility movements are known to be negatively correlated with stock index returns. Hence, investing in volatility appears to be attractive for investors seeking risk diversification. The most common instruments for investing in pure volatility are variance swaps, which now enjoy an active over-the-counter (OTC) market. This paper investigates the risk-return tradeoff of variance swaps on the Deutscher Aktienindex and Euro STOXX 50 index over the time period from 1995 to 2004. We synthetically derive variance swap rates from the smile in option prices. Using quotes from two large investment banks over two months, we validate that the synthetic values are close to OTC market prices. We find that variance swap returns exhibit an option-like profile compared to returns of the underlying index. Given this pattern, it is crucial to account for the non-normality of returns in measuring the performance of variance swap investments. As in the US, the average returns of selling variance swaps are found to be strongly positive and too large to be compatible with standard equilibrium models. The magnitude of the estimated risk premium is related to variance uncertainty and past index returns. This indicates that the variance swap rate does not seem to incorporate all past information relevant for forecasting future realized variance.

Suggested Citation

  • Reinhold Hafner & Martin Wallmeier, 2007. "Volatility as an Asset Class: European Evidence," The European Journal of Finance, Taylor & Francis Journals, vol. 13(7), pages 621-644.
  • Handle: RePEc:taf:eurjfi:v:13:y:2007:i:7:p:621-644
    DOI: 10.1080/13518470701380142

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    Cited by:

    1. Marie Briere & Alexandre Burgues & Ombretta Signori, 2008. "Volatility Exposure for Strategic Asset Allocation," Working Papers CEB 08-034.RS, ULB -- Universite Libre de Bruxelles.
    2. Ana-Maria Fuertes & Elena Kalotychou & Natasa Todorovic, 2015. "Daily volume, intraday and overnight returns for volatility prediction: profitability or accuracy?," Review of Quantitative Finance and Accounting, Springer, vol. 45(2), pages 251-278, August.
    3. Detering, Nils & Zhou, Qixiang & Wystup, Uwe, 2012. "Volatilität als Investment: Diversifikationseigenschaften von Volatilitätsstrategien," CPQF Working Paper Series 30, Frankfurt School of Finance and Management, Centre for Practical Quantitative Finance (CPQF).
    4. Martin Wallmeier, 2011. "Beyond payoff diagrams: how to present risk and return characteristics of structured products," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 25(3), pages 313-338, September.


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