An Investor’s Perspective on Volatility as an Asset Class: Evidence from the European Stock Market

Content Provider	Semantic Scholar
Author	Hafner, Reinhold Wallmeier, Martin
Copyright Year	2005
Abstract	Volatility movements are known to be negatively correlated with stock index returns. Hence, investing in volatility appears to be attractive for investors seeking risk diversification. The most common instruments for investing in pure volatility are variance swaps, which now enjoy an active over-the-counter market. This paper investigates the risk-return tradeoff of variance swaps on the “Deutscher Aktienindex” (DAX) and EuroStoxx50 index (ESX) over the time period of 1995 to 2004. We synthetically derive variance swap prices from the smile in option prices, which we estimate using transaction data. Our objective is to analyze the relationship between index and variance swap returns and to draw conclusions for investors. Empirically, the profile of log swap returns against log index returns on average resembles the payoff of a long put position. This highlights that variance swaps provide crash protection to investors. However, the market price of crash protection is suprisingly high. In line with previous U.S. evidence, we find a strongly negative volatility risk premium at the German as well as the European stock market. Its magnitude is not compatible with standard equilibrium pricing models. Thus, selling realized volatility seems to be a profitable strategy. Our backtests result in significant portfolio weights of the short volatility position during the sample period. Thus, our findings contradict recommendations of major investment banks and investment consultants to integrate long volatility positions into equity portfolios. JEL classification: G10; G12; G13
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Alternate Webpage(s)	http://www.fbv.kit.edu/symposium/10th/papers/Wallmeier_Hafner%20-%20An%20Investors%20Perspective%20on%20Volatility%20as%20an%20Asset%20Class%20Evidence%20from%20the%20European%20Stock%20Market.pdf
Language	English
Access Restriction	Open
Content Type	Text
Resource Type	Article