The Price of Variance Risk
The average investor in the variance swap market is indifferent to news about future
variance at horizons ranging from 1 month to 14 years. It is only purely transitory
and unexpected realized variance that is priced. These results present a challenge
to most structural models of the variance risk premium, such as the intertemporal
CAPM, recent models with Epstein-Zin preferences and long-run risks, and models
where institutional investors have value-at-risk constraints. The results also have strong implications for macro models where volatility affects investment decisions, suggesting that investors are not willing to pay to hedge shocks in expected economic uncertainty.
Dew-Becker, Ian and Marius Rodriguez. Forthcoming. The Price of Variance Risk. Journal of Financial Economics.