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The Decline of the Variance Risk Premium: Evidence from Traded and Synthetic Options

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  • Ian Dew-Becker
  • Stefano Giglio

Abstract

Equity index options historically displayed sharply negative returns and CAPM alphas. This could reflect investor risk preferences or intermediary frictions. We document that over the past 15 years, option alphas have become indistinguishable from zero. We also introduce synthetic options, that, under some conditions, reflect risk preferences of the average equity investor, independent of option-market frictions. Synthetic options never, over the last 100 years, had negative alpha, indicating that equity investors never required high compensation for market downturns. An intermediary-based model explains the patterns in both synthetic and traded options, including the recent decline in the variance risk premium.

Suggested Citation

  • Ian Dew-Becker & Stefano Giglio, 2025. "The Decline of the Variance Risk Premium: Evidence from Traded and Synthetic Options," Working Paper Series WP 2025-17, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:101806
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    File URL: https://www.chicagofed.org/publications/working-papers/2025/2025-17
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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