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The Variation in Variance Risk Premium and its Predictive Power: Evidence from Option Market Sentiments

Author

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  • Y. Peter Chung

    (School of Business, University of California, Riverside, CA, USA)

  • Sun-Joong Yoon

    (Dongguk Business School, Dongguk University, Seoul, South Korea)

Abstract

We show that the highly volatile variance risk premium (VRP) can be theoretically and empirically reconciled with investor sentiment captured by temporary variation in risk aversion. In an effort to understand the poor predictive power of the VRP in non-U.S. markets, we propose a new investor sentiment index, the Variance Sentiment Index(VSI), obtained from the trading behavior of individual investors. We show that the VSI predicts local return dynamics, in a similar way to what the VRP does in the U.S. market. Moreover, the VSI does not lose its predictive power even in the presence of the global VRP.

Suggested Citation

  • Y. Peter Chung & Sun-Joong Yoon, 2020. "The Variation in Variance Risk Premium and its Predictive Power: Evidence from Option Market Sentiments," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 10(03), pages 1-46, September.
    • Handle: RePEc:wsi:qjfxxx:v:10:y:2020:i:03:n:s201013922050010x
    DOI: 10.1142/S201013922050010X
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