The term structure of the price of variance risk

Abstract: We estimate the term structure of the price of variance risk (PVR), which helps distinguish between competing asset-pricing theories. First, we measure the PVR as proportional to the Sharpe ratio of short-term holding returns of delta-neutral index straddles; second, we estimate the PVR in a Heston (1993) stochastic-volatility model. In both cases, the estimation is performed separately for different maturities. We find the PVR is negative and decreases in absolute value with maturity; it is more negative and its term structure is steeper when volatility is high. These findings are inconsistent with calibrations of established asset-pricing models that assume constant risk aversion across maturities.

Keywords: straddle; term structure; option returns; volatility risk;

JEL Classification: G13; G12;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2015-08-01

Number: 736

Pages: 34 pages