The term structure of the price of variance risk

Andries, Marianne; Eisenbach, Thomas M.; Kahn, R. Jay; Schmalz, Martin C.

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The term structure of the price of variance risk

Abstract: We empirically investigate the term structure of variance risk pricing and how it varies over time. We estimate the aversion to variance risk in a stochastic-volatility option pricing model separately for options of different maturities and find that variance risk pricing decreases in absolute value with maturity but remains significantly different from zero up to the nine-month horizon. We find consistent non-parametric results using estimates from Sharpe ratios of delta-neutral straddles. We further show that the term structure is downward sloping both during normal times and in times of stress, when required compensation for variance risk increases and its term structure steepens further.

Keywords: volatility risk; option returns; term structure;

JEL Classification: G12; G13;