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The Volatility Premium

Author

Listed:
  • Bjorn Eraker

    (Wisconsin School of Business, University of Wisconsin-Madison, USA)

Abstract

The difference, average risk-neutral and physical volatility, is substantial and translates into a large return premium for sellers of index options. This paper studies a general equilibrium model based on long-run risk in an effort to explain the premium. In estimating the model using data on stock returns and volatility (VIX), the model captures the premium and also the large negative correlation between shocks to volatility and stock prices. Numerical simulations verify that writers of index options earn high rates of return in equilibrium and that the return patterns are similar to that seen in the S&P 500 index options data.

Suggested Citation

  • Bjorn Eraker, 2021. "The Volatility Premium," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 11(03), pages 1-35, September.
    • Handle: RePEc:wsi:qjfxxx:v:11:y:2021:i:03:n:s2010139221500142
    DOI: 10.1142/S2010139221500142
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    Cited by:

    1. Lago-Balsalobre, Rubén & Rojo-Suárez, Javier & Alonso-Conde, Ana B., 2023. "Cross-sectional implications of dynamic asset pricing with stochastic volatility and ambiguity aversion," The North American Journal of Economics and Finance, Elsevier, vol. 66(C).
    2. Bjørn Eraker & Aoxiang Yang, 2022. "The Price of Higher Order Catastrophe Insurance: The Case of VIX Options," Journal of Finance, American Finance Association, vol. 77(6), pages 3289-3337, December.
    3. Philip Stahl, 2022. "Asymptotic extrapolation of model-free implied variance: exploring structural underestimation in the VIX Index," Review of Derivatives Research, Springer, vol. 25(3), pages 315-339, October.

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