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Realized GARCH, CBOE VIX, and the Volatility Risk Premium

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  • Peter Reinhard Hansen
  • Zhuo Huang
  • Chen Tong
  • Tianyi Wang

Abstract

We show that the Realized GARCH model yields close-form expression for both the Volatility Index (VIX) and the volatility risk premium (VRP). The Realized GARCH model is driven by two shocks, a return shock and a volatility shock, and these are natural state variables in the stochastic discount factor (SDF). The volatility shock endows the exponentially affine SDF with a compensation for volatility risk. This leads to dissimilar dynamic properties under the physical and risk-neutral measures that can explain time-variation in the VRP. In an empirical application with the S&P 500 returns, the VIX, and the VRP, we find that the Realized GARCH model significantly outperforms conventional GARCH models.

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  • Peter Reinhard Hansen & Zhuo Huang & Chen Tong & Tianyi Wang, 2021. "Realized GARCH, CBOE VIX, and the Volatility Risk Premium," Papers 2112.05302, arXiv.org.
    • Handle: RePEc:arx:papers:2112.05302
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    Cited by:

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