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Volatility-Decay Risk Premia

Dan Galai, Haim Kedar-Levy and Ben Z. Schreiber
The Journal of Derivatives Fall 2014, 22 (1) 57-70; DOI: https://doi.org/10.3905/jod.2014.22.1.057
Dan Galai
is the Abe Gray Professor (Emeritus) of Banking and Finance at the School of Business Administration, Hebrew University in Jerusalem, Israel, and the Center for Academic Studies in Or Yehuda, Israel.
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  • For correspondence: dan.galai@huji.ac.il
Haim Kedar-Levy
is on the Faculty of Business and Management at Ben Gurion University of the Negev in Beer Sheva, Israel, and Ono Academic College in Kiryat Ono, Israel.
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  • For correspondence: hlevy@som.bgu.ac.il
Ben Z. Schreiber
is the head of the Methodology and Economics Area, Information and Statistics Department, Bank of Israel in Jerusalem, and Bar Ilan University in Ramat Gan, Israel.
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  • For correspondence: ben.schreiber58@gmail.com
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Abstract

As our options models have gotten more realistic, but more complicated, there are more and more relevant risks that pose serious concerns for investors. Current models feature stochastic diffusive volatility, stochastic jumps of random magnitude to returns and/or volatility, with different effects for up and down jumps, and more. Empirical evidence shows that diffusive volatility goes up following a large jump, and then gradually reverts back to normal levels. However, investors don’t know how fast this will occur, so reversion uncertainty is another risk they face and for which they may require compensation. In this article, the authors explore such volatility decay risk premia using a clever technique based on time-spreads of delta and gamma-neutral straddles. They find a significant effect and show that it is tied to the occurrence of jumps and related to changes in the S&P 500 and the VIX.

TOPICS: Options, quantitative methods

  • © 2014 Institutional Investor, Inc.
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The Journal of Derivatives: 22 (1)
The Journal of Derivatives
Vol. 22, Issue 1
Fall 2014
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Volatility-Decay Risk Premia
Dan Galai, Haim Kedar-Levy, Ben Z. Schreiber
The Journal of Derivatives Aug 2014, 22 (1) 57-70; DOI: 10.3905/jod.2014.22.1.057

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Volatility-Decay Risk Premia
Dan Galai, Haim Kedar-Levy, Ben Z. Schreiber
The Journal of Derivatives Aug 2014, 22 (1) 57-70; DOI: 10.3905/jod.2014.22.1.057
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  • Article
    • Abstract
    • HYPOTHESES, METHODOLOGY, AND DATA
    • SUMMARY STATISTICS
    • VOLATILITY-DECAY RISK PREMIA
    • EXPLANATORY FACTORS FOR VOLATILITY DECAY PREMIA
    • SUMMARY
    • ENDNOTES
    • REFERENCES
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