Volatility as an Asset Class: European Evidence
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.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 13 (2007)
Issue (Month): 7 ()
|Contact details of provider:|| Web page: http://www.tandfonline.com/REJF20|
|Order Information:||Web: http://www.tandfonline.com/pricing/journal/REJF20|