Variance risk, financial intermediation, and the cross-section of expected option returns

Details

Serval ID
serval:BIB_CC77B751042E
Type
Report: a report published by a school or other institution, usually numbered within a series.
Publication sub-type
Working paper: Working papers contain results presented by the author. Working papers aim to stimulate discussions between scientists with interested parties, they can also be the basis to publish articles in specialized journals
Collection
Publications
Institution
Title
Variance risk, financial intermediation, and the cross-section of expected option returns
Author(s)
Schuerhoff N., Ziegler A.
Institution details
CEPR - Centre for Economic Policy Research
Address
London, UK
Issued date
02/2011
Number
8268
Genre
Discussion paper
Language
english
Number of pages
69
Abstract
We explore the pricing of variance risk by decomposing stocks' total variance into systematic and idiosyncratic return variances. While systematic variance risk exhibits a negative price of risk, common shocks to the variances of idiosyncratic returns carry a large positive risk premium. This implies investors pay for insurance against increases (declines) in systematic (idiosyncratic) variance, even though both variances comove countercyclically. Common idiosyncratic variance risk is an important determinant for the cross-section of expected option returns. These findings reconcile several phenomena, including the pricing differences between index and stock options, the cross-sectional variation in stock option expensiveness, the volatility mispricing puzzle, and the significant returns earned on various option portfolio strategies. Our results are consistent with theories of financial intermediation under capital constraints.
Create date
20/11/2012 16:51
Last modification date
21/08/2019 6:17
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