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Delta-Hedged Gains and the Negative Market Volatility Risk Premium

Delta-Hedged Gains and the Negative Market Volatility Risk Premium We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility risk premium and the mean delta-hedged portfolio returns. Using a sample of S&P 500 index options, we provide empirical tests that have the following general results. First, the delta-hedged strategy underperforms zero. Second, the documented underperformance is less for options away from the money. Third, the underperformance is greater at times of higher volatility. Fourth, the volatility risk premium significantly affects delta-hedged gains, even after accounting for jump fears. Our evidence is supportive of a negative market volatility risk premium. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

Delta-Hedged Gains and the Negative Market Volatility Risk Premium

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Publisher
Oxford University Press
Copyright
© 2003 The Society for Financial Studies
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhg002
Publisher site
See Article on Publisher Site

Abstract

We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility risk premium and the mean delta-hedged portfolio returns. Using a sample of S&P 500 index options, we provide empirical tests that have the following general results. First, the delta-hedged strategy underperforms zero. Second, the documented underperformance is less for options away from the money. Third, the underperformance is greater at times of higher volatility. Fourth, the volatility risk premium significantly affects delta-hedged gains, even after accounting for jump fears. Our evidence is supportive of a negative market volatility risk premium.

Journal

The Review of Financial StudiesOxford University Press

Published: Apr 21, 2003

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