Market participants rushed to purchase protection, with VIX soaring to above 18 from below 13 a few days ago. What is the impact of this increase on the Variance Risk Premium? Result – not massive – the implied volatility rose pretty much in line with the realized.
Author(s): Jens Jackwerth, Grigory Vilkov
Date: September 23, 2013
Abstract: Using non-parametric methods to model the dependencies between risk-neutral distributions of the market index (S&P 500) and its expected volatility (VIX), we show how to extract the expected risk-neutral correlation between the index and its future expected volatility. Comparing the implied correlation to its realized counterpart reveals a significant risk premium priced into the index-volatility correlation, which can be interpreted as the compensation for the fear of rising volatility during and after a market crash, i.e., fear of crash continuation for a prolonged period of time. We show how the index-volatility correlation premium is related to future market returns and explain its economics.