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How Does the Market Variance Risk Premium Vary over Time? Evidence from S&P 500 Variance Swap Investment Returns

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  • Eirini Konstantinidi

    () (University of Manchester)

  • George Skiadopoulos

    () (Queen Mary University of London University of Piraeus)

Abstract

We explore whether the market variance risk premium (VRP) can be predicted. First, we propose a novel approach to measure VRP which distinguishes the investment horizon from the variance swap's maturity. We extract VRP from actual rather than synthetic S&P 500 variance swap quotes, thus avoiding biases in VRP measurement. Next, we find that a deterioration of the economy and of the trading activity, increases VRP. These relations hold both in- and out-of-sample for various maturities and investment horizons and they are economically significant. Volatility trading strategies which condition on the detected relations outperform popular buy-and-hold strategies even after transaction costs are considered.

Suggested Citation

  • Eirini Konstantinidi & George Skiadopoulos, 2014. "How Does the Market Variance Risk Premium Vary over Time? Evidence from S&P 500 Variance Swap Investment Returns," Working Papers 732, Queen Mary University of London, School of Economics and Finance.
  • Handle: RePEc:qmw:qmwecw:wp732
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    Cited by:

    1. Carol Alexander & Johannes Rauch, 2017. "The Aggregation Property and its Applications to Realised Higher Moments," Papers 1709.08188, arXiv.org.
    2. Carol Alexander & Johannes Rauch, 2016. "Model-Free Discretisation-Invariant Swap Contracts," Papers 1602.00235, arXiv.org, revised Apr 2016.
    3. Johannes Rauch & Carol Alexander, 2016. "Tail Risk Premia for Long-Term Equity Investors," Papers 1602.00865, arXiv.org.
    4. repec:eee:ejores:v:262:y:2017:i:1:p:381-400 is not listed on IDEAS

    More about this item

    Keywords

    Economic conditions; Predictability; Trading activity; Variance swaps; Variance risk premium; Volatility trading;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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