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Term spreads of implied volatility smirk and variance risk premium

Author

Listed:
  • Wei Guo
  • Xinfeng Ruan
  • Sebastian A. Gehricke
  • Jin E. Zhang

Abstract

In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in‐sample and out‐of‐sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.

Suggested Citation

  • Wei Guo & Xinfeng Ruan & Sebastian A. Gehricke & Jin E. Zhang, 2023. "Term spreads of implied volatility smirk and variance risk premium," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(7), pages 829-857, July.
    • Handle: RePEc:wly:jfutmk:v:43:y:2023:i:7:p:829-857
    DOI: 10.1002/fut.22409
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