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Credit Variance Risk Premiums

Author

Listed:
  • Manuel Ammann
  • Mathis Mörke

Abstract

This paper studies variance risk premiums in the credit market. Using a novel data set of swaptions quotes on the CDX North America Investment Grade index, we find that returns of credit variance swaps are negative and economically large. Shorting variance swaps yields an annualized Sharpe ratio of almost six, eclipsing its counterpart in fixed income or equity markets. The returns remain highly statistically significant when accounting for transaction costs, cannot be explained by established risk-factors, and hold for various investment horizons. We also dissect the overall variance risk premium into payer and receiver variance risk premiums. We find that exposure to both parts is priced. However, the returns for payer variance, associated with bad economic states, are roughly twice as high in absolute terms.

Suggested Citation

  • Manuel Ammann & Mathis Mörke, 2019. "Credit Variance Risk Premiums," Working Papers on Finance 1908, University of St. Gallen, School of Finance.
  • Handle: RePEc:usg:sfwpfi:2019:08
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    More about this item

    Keywords

    Variance risk premium; CDS implied volatility; CDS variance swap;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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