Term spreads of implied volatility smirk and variance risk premium

Wei Guo; Xinfeng Ruan; Sebastian A. Gehricke; Jin E. Zhang

doi:10.1002/fut.22409

Term spreads of implied volatility smirk and variance risk premium

Wei Guo, Xinfeng Ruan^*, Sebastian A. Gehricke, Jin E. Zhang^*

^*Corresponding author for this work

Department of Finance

Research output: Contribution to journal › Article › peer-review

1 Citation (Scopus)

Abstract

In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in-sample and out-of-sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.

Original language	English
Pages (from-to)	829-857
Journal	Journal of Futures Markets
Volume	43
Issue number	7
DOIs	https://doi.org/10.1002/fut.22409
Publication status	Published - Jul 2023

Keywords

SPX options
implied volatility
prediction
term spread
variance risk premium

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10.1002/fut.22409

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Guo, W., Ruan, X., Gehricke, S. A., & Zhang, J. E. (2023). Term spreads of implied volatility smirk and variance risk premium. Journal of Futures Markets, 43(7), 829-857. https://doi.org/10.1002/fut.22409

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title = "Term spreads of implied volatility smirk and variance risk premium",

abstract = "In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in-sample and out-of-sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.",

keywords = "SPX options, implied volatility, prediction, term spread, variance risk premium",

author = "Wei Guo and Xinfeng Ruan and Gehricke, {Sebastian A.} and Zhang, {Jin E.}",

note = "Funding Information: We would like to acknowledge the helpful comments and suggestions from Bart Frijns (the editor) and an anonymous referee. Jin E. Zhang has been supported by an establishment grant from the University of Otago. Open access publishing facilitated by University of Otago, as part of the Wiley - University of Otago agreement via the Council of Australian University Librarians. Funding Information: We would like to acknowledge the helpful comments and suggestions from Bart Frijns (the editor) and an anonymous referee. Jin E. Zhang has been supported by an establishment grant from the University of Otago. Open access publishing facilitated by University of Otago, as part of the Wiley ‐ University of Otago agreement via the Council of Australian University Librarians. Publisher Copyright: {\textcopyright} 2023 The Authors. The Journal of Futures Markets published by Wiley Periodicals LLC.",

year = "2023",

month = jul,

doi = "10.1002/fut.22409",

language = "English",

volume = "43",

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AU - Guo, Wei

AU - Ruan, Xinfeng

AU - Gehricke, Sebastian A.

AU - Zhang, Jin E.

N1 - Funding Information: We would like to acknowledge the helpful comments and suggestions from Bart Frijns (the editor) and an anonymous referee. Jin E. Zhang has been supported by an establishment grant from the University of Otago. Open access publishing facilitated by University of Otago, as part of the Wiley - University of Otago agreement via the Council of Australian University Librarians. Funding Information: We would like to acknowledge the helpful comments and suggestions from Bart Frijns (the editor) and an anonymous referee. Jin E. Zhang has been supported by an establishment grant from the University of Otago. Open access publishing facilitated by University of Otago, as part of the Wiley ‐ University of Otago agreement via the Council of Australian University Librarians. Publisher Copyright: © 2023 The Authors. The Journal of Futures Markets published by Wiley Periodicals LLC.

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N2 - In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in-sample and out-of-sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.

AB - In this paper, we study the pattern of S&P 500 index options implied volatility (IV) curves and their predictive ability for the variance risk premium (VRP). We explore this predictability employing by the Zhang and Xiang IV factor estimation. We show that the level factor term spread significantly predicts the VRP, proxied by straddle returns and variance swap returns, in both in-sample and out-of-sample tests. The predictability is more pronounced for straddle returns rather than variance swap returns.

KW - SPX options

KW - implied volatility

KW - prediction

KW - term spread

KW - variance risk premium

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JO - Journal of Futures Markets

JF - Journal of Futures Markets

IS - 7

ER -

Term spreads of implied volatility smirk and variance risk premium

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