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The economics of the financial market for volatility trading

Author

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  • Ruan, Xinfeng
  • Zhang, Jin E.

Abstract

We examine the economics of the financial market for volatility trading based on an equilibrium model with three kinds of traders: dealers, asset managers, and leveraged funds. Our model reveals that the negative price of volatility is due to the high short positions of dealers, low short positions of leveraged funds, and high long positions of asset managers. It also explains well the negative variance risk premium and the negative returns of volatility derivatives. Our empirical analysis based on VIX futures position data with weekly frequency from 2006 to 2016, furthermore, supports the model's implications.

Suggested Citation

  • Ruan, Xinfeng & Zhang, Jin E., 2021. "The economics of the financial market for volatility trading," Journal of Financial Markets, Elsevier, vol. 52(C).
    • Handle: RePEc:eee:finmar:v:52:y:2021:i:c:s1386418120300252
    DOI: 10.1016/j.finmar.2020.100556
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    Cited by:

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    More about this item

    Keywords

    Volatility trading; Variance risk premium; VIX futures; Equilibrium;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • 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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