The economics of the financial market for volatility trading

Xinfeng Ruan; Jin E. Zhang

doi:10.1016/j.finmar.2020.100556

The economics of the financial market for volatility trading

Xinfeng Ruan^*
, Jin E. Zhang

^*Corresponding author for this work

University of Otago

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

6 Citations (Scopus)

Abstract

We examine the economics of the financial market for volatility trading based on an equilibrium model with three kinds of traders: dealers, asset managers, and leveraged funds. Our model reveals that the negative price of volatility is due to the high short positions of dealers, low short positions of leveraged funds, and high long positions of asset managers. It also explains well the negative variance risk premium and the negative returns of volatility derivatives. Our empirical analysis based on VIX futures position data with weekly frequency from 2006 to 2016, furthermore, supports the model's implications.

Original language	English
Article number	100556
Journal	Journal of Financial Markets
Volume	52
DOIs	https://doi.org/10.1016/j.finmar.2020.100556
Publication status	Published - Jan 2021
Externally published	Yes

Keywords

Equilibrium
VIX futures
Variance risk premium
Volatility trading

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10.1016/j.finmar.2020.100556

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title = "The economics of the financial market for volatility trading",

abstract = "We examine the economics of the financial market for volatility trading based on an equilibrium model with three kinds of traders: dealers, asset managers, and leveraged funds. Our model reveals that the negative price of volatility is due to the high short positions of dealers, low short positions of leveraged funds, and high long positions of asset managers. It also explains well the negative variance risk premium and the negative returns of volatility derivatives. Our empirical analysis based on VIX futures position data with weekly frequency from 2006 to 2016, furthermore, supports the model's implications.",

keywords = "Equilibrium, VIX futures, Variance risk premium, Volatility trading",

author = "Xinfeng Ruan and Zhang, \{Jin E.\}",

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AB - We examine the economics of the financial market for volatility trading based on an equilibrium model with three kinds of traders: dealers, asset managers, and leveraged funds. Our model reveals that the negative price of volatility is due to the high short positions of dealers, low short positions of leveraged funds, and high long positions of asset managers. It also explains well the negative variance risk premium and the negative returns of volatility derivatives. Our empirical analysis based on VIX futures position data with weekly frequency from 2006 to 2016, furthermore, supports the model's implications.

KW - Equilibrium

KW - VIX futures

KW - Variance risk premium

KW - Volatility trading

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The economics of the financial market for volatility trading

Abstract

Keywords

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