Publication: Variance Swaps and Intertemporal Asset Pricing
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2011-04
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Facultad de CC Económicas y Empresariales. Instituto Complutense de Análisis Económico
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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
premium to be priced in the market. We report relatively favorable evidence on the incremental pricing information associated with the variance risk premium, particularly
at shorter horizons.
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JEL classification: C13, C14, G10, G12.
The authors
thank seminar participants at the 33th Meeting of the European Accounting Association, the 8th INFINITI
Conference on International Finance, and XVII Foro de Finanzas, IESE, and especially Enrique Sentana,
for constructive comments.
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