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Variance Swaps and Intertemporal Asset Pricing

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Abstract

This paper proposes an ICAPM in which the risk premium embedded in variance swaps is the factor mimicking portfolio for hedging exposure to changes in future investment conditions. Recent empirical evidence shows that the fears by investors to deviations from Normality in the distribution of returns are able to explain time-varying financial and macroeconomic risks in addition to being a determinant of the variance risk premium. Moreover, variance swaps hedges unfavorable changes in the stochastic investment opportunity set, and is not a redundant asset because significantly expands the efficient mean-variance frontier. Thence, we should expect the variance swap risk incremental pricing information associated with the variance risk premium, particularly at shorter horizons.

Suggested Citation

  • Belén Nieto & Alfonso Novales Cinca & Gonzalo Rubio, 2011. "Variance Swaps and Intertemporal Asset Pricing," Documentos de Trabajo del ICAE 2011-08, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    • Handle: RePEc:ucm:doicae:1108
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    References listed on IDEAS

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    More about this item

    Keywords

    variance risk premium; intertemporal asset pricing;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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