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Variance Risk Premiums in Foreign Exchange Markets

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  • Ammann, Manuel

    ()

  • Buesser, Ralf

    ()

Abstract

Based on the theory of static replication of variance swaps we assess the sign and magnitude of variance risk premiums in foreign exchange markets. We find significantly negative risk premiums when realized variance is computed from intraday data with low frequency. As a likely consequence of microstructure effects however, the evidence is ambiguous when realized variance is based on high-frequency data. Common to all estimates, variance risk premiums are highly time-varying and inversely related to the risk-neutral expectation of future variance. When we test whether variance risk premiums can be attributed to classic risk factors or fear of jump risk, we find that conditional premiums remain significantly negative. However, we observe a strong relationship between the size of log variance risk premiums and the VIX, the TED spread and the general shape of the implied volatility function of the corresponding currency pair. Overall, we conclude that there is a separately priced variance risk factor which commands a highly time-varying premium.

Suggested Citation

  • Ammann, Manuel & Buesser, Ralf, 2013. "Variance Risk Premiums in Foreign Exchange Markets," Working Papers on Finance 1304, University of St. Gallen, School of Finance.
  • Handle: RePEc:usg:sfwpfi:2013:04
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    File URL: http://ux-tauri.unisg.ch/RePEc/usg/sfwpfi/WPF-1304.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Johannes Rauch & Carol Alexander, 2016. "Tail Risk Premia for Long-Term Equity Investors," Papers 1602.00865, arXiv.org.
    2. Gurdip Bakshi & Mario Cerrato & John Crosby, 2016. "Studying the Implications of Consumption and Asset Return Data for Stochastic Discount Factors in Incomplete International Economies," Working Papers 2017_01, Business School - Economics, University of Glasgow.
    3. Carol Alexander & Johannes Rauch, 2016. "Model-Free Discretisation-Invariant Swap Contracts," Papers 1602.00235, arXiv.org, revised Apr 2016.

    More about this item

    Keywords

    Foreign exchange; variance risk premium; variance swap; intraday data; risk- neutral expectation; jump risk.;

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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