Department of Economics and Business Economics

Variance swap payoffs, risk premia and extreme market conditions

Research output: Working paper/Preprint Working paperResearch


  • rp17_21

    Final published version, 0.99 MB, PDF document

  • Jeroen V.K. Rombouts, ESSEC Business School, France
  • Lars Stentoft, HEC Montreal, 1 National Centre for Register-based Research, School of Business and Social Sciences, Department of Economics and Business, Aarhus University , Aarhus, Denmark ., Canada
  • Francesco Violante
This paper estimates the Variance Risk Premium (VRP) directly from synthetic variance swap payoffs. Since variance swap payoffs are highly volatile, we extract the VRP by using signal extraction techniques based on a state-space representation of our model in combination with a simple economic constraint. Our approach, only requiring option implied volatilities and daily returns for the underlying, provides measurement error free estimates of the part of the VRP related to normal market conditions, and allows constructing variables indicating agents' expectations under extreme market conditions. The latter variables and the VRP generate different return predictability on the major US indices. A factor model is proposed to extract a market VRP which turns out to be priced when considering Fama and French portfolios.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages46
Publication statusPublished - 30 May 2017
SeriesCREATES Research Papers

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