Volatility-decay risk premia

Dan Galai, Haim Kedar-Levy, Ben Z. Schreiber

Research output: Contribution to journalArticlepeer-review

2 Scopus citations

Abstract

As our options models have gotten more realistic, but more complicated, there are more and more relevant risks that pose serious concerns for investors. Current models feature stochastic diffusive volatility, stochastic jumps of random magnitude to returns and/or volatility, with different effects for up and down jumps, and more. Empirical evidence shows that diffusive volatility goes up following a large jump, and then gradually reverts back to normal levels. However, investors don't know how fast this will occur, so reversion uncertainty is another risk they face and for which they may require compensation. In this article, the authors explore such volatility decay risk premia using a clever technique based on time-spreads of delta and gamma-neutral straddles. They find a significant effect and show that it is tied to the occurrence of jumps and related to changes in the S&P 500 and the VIX.

Original languageEnglish
Pages (from-to)57-70
Number of pages14
JournalJournal of Derivatives
Volume22
Issue number1
DOIs
StatePublished - 1 Sep 2014

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