IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v95y2018icp44-63.html
   My bibliography  Save this article

Risk factors and their associated risk premia: An empirical analysis of the crude oil market

Author

Listed:
  • Hain, Martin
  • Uhrig-Homburg, Marliese
  • Unger, Nils

Abstract

This paper sheds new light on higher-order price risks in crude oil markets. A model-free analysis reveals that crude oil variance risk behaves fundamentally different from variance risk in equity markets. Most importantly, a skewness swap is no valid hedge for a variance swap and investors fear large price jumps in both directions. A model-based assessment confirms this and reveals that while stochastic volatility is important to capture the statistical properties such as volatility clusters and time-varying variance swap rates, only jump risk seems to be priced with a premium. Empirical evidence from a pricing and hedging exercise confirms these findings.

Suggested Citation

  • Hain, Martin & Uhrig-Homburg, Marliese & Unger, Nils, 2018. "Risk factors and their associated risk premia: An empirical analysis of the crude oil market," Journal of Banking & Finance, Elsevier, vol. 95(C), pages 44-63.
    • Handle: RePEc:eee:jbfina:v:95:y:2018:i:c:p:44-63
    DOI: 10.1016/j.jbankfin.2017.10.007
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426617302534
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2017.10.007?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Prokopczuk, Marcel & Symeonidis, Lazaros & Wese Simen, Chardin, 2017. "Variance risk in commodity markets," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 136-149.
    2. Anders B. Trolle & Eduardo S. Schwartz, 2009. "Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4423-4461, November.
    3. Tim Bollerslev & George Tauchen & Hao Zhou, 2009. "Expected Stock Returns and Variance Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4463-4492, November.
    4. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.
    5. Bakshi, Gurdip & Cao, Charles & Chen, Zhiwu, 1997. "Empirical Performance of Alternative Option Pricing Models," Journal of Finance, American Finance Association, vol. 52(5), pages 2003-2049, December.
    6. Lutz Kilian, 2016. "The Impact of the Shale Oil Revolution on U.S. Oil and Gasoline Prices," Review of Environmental Economics and Policy, Association of Environmental and Resource Economists, vol. 10(2), pages 185-205.
    7. Tim Bollerslev & Viktor Todorov, 2011. "Tails, Fears, and Risk Premia," Journal of Finance, American Finance Association, vol. 66(6), pages 2165-2211, December.
    8. Chris Brooks & Marcel Prokopczuk, 2013. "The dynamics of commodity prices," Quantitative Finance, Taylor & Francis Journals, vol. 13(4), pages 527-542, March.
    9. Gurdip Bakshi & Nikunj Kapadia, 2003. "Delta-Hedged Gains and the Negative Market Volatility Risk Premium," The Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 527-566.
    10. Jones, Christopher S., 2003. "The dynamics of stochastic volatility: evidence from underlying and options markets," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 181-224.
    11. Viktor Todorov, 2010. "Variance Risk-Premium Dynamics: The Role of Jumps," The Review of Financial Studies, Society for Financial Studies, vol. 23(1), pages 345-383, January.
    12. repec:bla:jfinan:v:59:y:2004:i:3:p:1367-1404 is not listed on IDEAS
    13. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 33(1), pages 125-132.
    14. Andreas Kaeck & Carol Alexander, 2013. "Stochastic Volatility Jump†Diffusions for European Equity Index Dynamics," European Financial Management, European Financial Management Association, vol. 19(3), pages 470-496, June.
    15. Anders B. Trolle & Eduardo S. Schwartz, 2014. "The Swaption Cube," The Review of Financial Studies, Society for Financial Studies, vol. 27(8), pages 2307-2353.
    16. Mark Broadie & Mikhail Chernov & Michael Johannes, 2007. "Model Specification and Risk Premia: Evidence from Futures Options," Journal of Finance, American Finance Association, vol. 62(3), pages 1453-1490, June.
    17. Bing Han, 2008. "Investor Sentiment and Option Prices," The Review of Financial Studies, Society for Financial Studies, vol. 21(1), pages 387-414, January.
    18. Bates, David S., 2005. "Hedging the smirk," Finance Research Letters, Elsevier, vol. 2(4), pages 195-200, December.
    19. Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
    20. David J. Spiegelhalter & Nicola G. Best & Bradley P. Carlin & Angelika Van Der Linde, 2002. "Bayesian measures of model complexity and fit," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 64(4), pages 583-639, October.
    21. James Doran & Ehud Ronn, 2005. "The bias in Black-Scholes/Black implied volatility: An analysis of equity and energy markets," Review of Derivatives Research, Springer, vol. 8(3), pages 177-198, December.
    22. Alexander, Carol & Nogueira, Leonardo M., 2007. "Model-free hedge ratios and scale-invariant models," Journal of Banking & Finance, Elsevier, vol. 31(6), pages 1839-1861, June.
    23. Doran, James S. & Ronn, Ehud I., 2008. "Computing the market price of volatility risk in the energy commodity markets," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2541-2552, December.
    24. Roman Kozhan & Anthony Neuberger & Paul Schneider, 2013. "The Skew Risk Premium in the Equity Index Market," The Review of Financial Studies, Society for Financial Studies, vol. 26(9), pages 2174-2203.
    25. Hossein Asgharian & Christoffer Bengtsson, 2006. "Jump Spillover in International Equity Markets," Journal of Financial Econometrics, Oxford University Press, vol. 4(2), pages 167-203.
    26. Shleifer, Andrei & Vishny, Robert W, 1997. "The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    27. Bjørn Eraker & Michael Johannes & Nicholas Polson, 2003. "The Impact of Jumps in Volatility and Returns," Journal of Finance, American Finance Association, vol. 58(3), pages 1269-1300, June.
    28. Chernov, Mikhail & Ghysels, Eric, 2000. "A study towards a unified approach to the joint estimation of objective and risk neutral measures for the purpose of options valuation," Journal of Financial Economics, Elsevier, vol. 56(3), pages 407-458, June.
    29. I-Hsuan Ethan Chiang & W. Keener Hughen & Jacob S. Sagi, 2015. "Estimating Oil Risk Factors Using Information from Equity and Derivatives Markets," Journal of Finance, American Finance Association, vol. 70(2), pages 769-804, April.
    30. Barone-Adesi, Giovanni & Whaley, Robert E, 1987. "Efficient Analytic Approximation of American Option Values," Journal of Finance, American Finance Association, vol. 42(2), pages 301-320, June.
    31. George J. Jiang & Yisong S. Tian, 2005. "The Model-Free Implied Volatility and Its Information Content," The Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1305-1342.
    32. Jacquier, Eric & Polson, Nicholas G. & Rossi, P.E.Peter E., 2004. "Bayesian analysis of stochastic volatility models with fat-tails and correlated errors," Journal of Econometrics, Elsevier, vol. 122(1), pages 185-212, September.
    33. Martijn Cremers & Michael Halling & David Weinbaum, 2015. "Aggregate Jump and Volatility Risk in the Cross-Section of Stock Returns," Journal of Finance, American Finance Association, vol. 70(2), pages 577-614, April.
    34. Peter Carr & Liuren Wu, 2009. "Variance Risk Premiums," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1311-1341, March.
    35. Jefferson Duarte & Francis A. Longstaff & Fan Yu, 2007. "Risk and Return in Fixed-Income Arbitrage: Nickels in Front of a Steamroller?," The Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 769-811.
    36. Bates, David S., 2000. "Post-'87 crash fears in the S&P 500 futures option market," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 181-238.
    37. Bessembinder, Hendrik, 1992. "Systematic Risk, Hedging Pressure, and Risk Premiums in Futures Markets," The Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 637-667.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Alibeiki, Hedayat & Lotfaliei, Babak, 2022. "To expand and to abandon: Real options under asset variance risk premium," European Journal of Operational Research, Elsevier, vol. 300(2), pages 771-787.
    2. Manuel Ammann & Mathis Moerke & Marcel Prokopczuk & Christoph Matthias Würsig, 2023. "Commodity tail risks," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(2), pages 168-197, February.
    3. Kang, Boda & Nikitopoulos, Christina Sklibosios & Prokopczuk, Marcel, 2020. "Economic determinants of oil futures volatility: A term structure perspective," Energy Economics, Elsevier, vol. 88(C).
    4. Hain, Martin & Kargus, Tobias & Schermeyer, Hans & Uhrig-Homburg, Marliese & Fichtner, Wolf, 2022. "An electricity price modeling framework for renewable-dominant markets," Working Paper Series in Production and Energy 66, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Neumann, Maximilian & Prokopczuk, Marcel & Wese Simen, Chardin, 2016. "Jump and variance risk premia in the S&P 500," Journal of Banking & Finance, Elsevier, vol. 69(C), pages 72-83.
    2. Aït-Sahalia, Yacine & Karaman, Mustafa & Mancini, Loriano, 2020. "The term structure of equity and variance risk premia," Journal of Econometrics, Elsevier, vol. 219(2), pages 204-230.
    3. Maneesoonthorn, Worapree & Martin, Gael M. & Forbes, Catherine S. & Grose, Simone D., 2012. "Probabilistic forecasts of volatility and its risk premia," Journal of Econometrics, Elsevier, vol. 171(2), pages 217-236.
    4. Bardgett, Chris & Gourier, Elise & Leippold, Markus, 2019. "Inferring volatility dynamics and risk premia from the S&P 500 and VIX markets," Journal of Financial Economics, Elsevier, vol. 131(3), pages 593-618.
    5. Bondarenko, Oleg, 2014. "Variance trading and market price of variance risk," Journal of Econometrics, Elsevier, vol. 180(1), pages 81-97.
    6. Kaeck, Andreas & Rodrigues, Paulo & Seeger, Norman J., 2017. "Equity index variance: Evidence from flexible parametric jump–diffusion models," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 85-103.
    7. Markellos, Raphael N. & Psychoyios, Dimitris, 2018. "Interest rate volatility and risk management: Evidence from CBOE Treasury options," The Quarterly Review of Economics and Finance, Elsevier, vol. 68(C), pages 190-202.
    8. Filipović, Damir & Gourier, Elise & Mancini, Loriano, 2016. "Quadratic variance swap models," Journal of Financial Economics, Elsevier, vol. 119(1), pages 44-68.
    9. Shackleton, Mark B. & Taylor, Stephen J. & Yu, Peng, 2010. "A multi-horizon comparison of density forecasts for the S&P 500 using index returns and option prices," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2678-2693, November.
    10. Chen, Chin-Ho, 2019. "Downside jump risk and the levels of futures-cash basis," Pacific-Basin Finance Journal, Elsevier, vol. 57(C).
    11. Carol Alexander & Andreas Kaeck, 2012. "Does model fit matter for hedging? Evidence from FTSE 100 options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(7), pages 609-638, July.
    12. Du Du & Dan Luo, 2019. "The Pricing of Jump Propagation: Evidence from Spot and Options Markets," Management Science, INFORMS, vol. 67(5), pages 2360-2387, May.
    13. Benzoni, Luca & Collin-Dufresne, Pierre & Goldstein, Robert S., 2011. "Explaining asset pricing puzzles associated with the 1987 market crash," Journal of Financial Economics, Elsevier, vol. 101(3), pages 552-573, September.
    14. Amengual, Dante & Xiu, Dacheng, 2018. "Resolution of policy uncertainty and sudden declines in volatility," Journal of Econometrics, Elsevier, vol. 203(2), pages 297-315.
    15. Carverhill, Andrew & Luo, Dan, 2023. "A Bayesian analysis of time-varying jump risk in S&P 500 returns and options," Journal of Financial Markets, Elsevier, vol. 64(C).
    16. Gurdip Bakshi & Charles Cao & Zhaodong (Ken) Zhong, 2021. "Assessing models of individual equity option prices," Review of Quantitative Finance and Accounting, Springer, vol. 57(1), pages 1-28, July.
    17. Song, Zhaogang & Xiu, Dacheng, 2016. "A tale of two option markets: Pricing kernels and volatility risk," Journal of Econometrics, Elsevier, vol. 190(1), pages 176-196.
    18. Peter Van Tassel & Erik Vogt, 2016. "Global variance term premia and intermediary risk appetite," Staff Reports 789, Federal Reserve Bank of New York.
    19. Li, Gang & Zhang, Chu, 2013. "Diagnosing affine models of options pricing: Evidence from VIX," Journal of Financial Economics, Elsevier, vol. 107(1), pages 199-219.
    20. Audrino, Francesco & Fengler, Matthias R., 2015. "Are classical option pricing models consistent with observed option second-order moments? Evidence from high-frequency data," Journal of Banking & Finance, Elsevier, vol. 61(C), pages 46-63.

    More about this item

    Keywords

    Risk premia; Option pricing; Stochastic volatility; Jumps; Unspanned volatility; Hedging;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:95:y:2018:i:c:p:44-63. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.