The Variation in Variance Risk Premium and its Predictive Power: Evidence from Option Market Sentiments

Y. Peter Chung, Sun Joong Yoon

Research output: Contribution to journalArticlepeer-review

Abstract

We show that the highly volatile variance risk premium (VRP) can be theoretically and empirically reconciled with investor sentiment captured by temporary variation in risk aversion. In an effort to understand the poor predictive power of the VRP in non-U.S. markets, we propose a new investor sentiment index, the Variance Sentiment Index(VSI), obtained from the trading behavior of individual investors. We show that the VSI predicts local return dynamics, in a similar way to what the VRP does in the U.S. market. Moreover, the VSI does not lose its predictive power even in the presence of the global VRP.

Original languageEnglish
Article number22050010
JournalQuarterly Journal of Finance
Volume10
Issue number3
DOIs
StatePublished - 1 Sep 2020

Keywords

  • investor sentiment
  • KOSPI
  • S&P 500
  • TAIEX
  • Variance risk premium
  • Variance Sentiment Index

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