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

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 sentim...

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Bibliographic Details
Published in:The quarterly journal of finance 2020-09, Vol.10 (3), p.2050010
Main Authors: Chung, Y. Peter, Yoon, Sun-Joong
Format: Article
Language:English
Subjects:
Investor behavior
Markets
Power
Risk
Risk premiums
Trading
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Description
Summary: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.
ISSN:2010-1392
2010-1406
DOI:10.1142/S201013922050010X