How Aggregate Volatility-of-Volatility Affects Stock Returns. (24th July 2017)

• Record Type: Journal Article
• Authors: Hollstein, Fabian; Prokopczuk, Marcel
• Is Part Of: Review of asset pricing studies. Volume 8:Number 2(2018:Dec.)
• Page Start: 253
• Page End: 292
• Publication Date: 2017-07-24
• Subjects: Capital assets pricing model -- Periodicals; Stocks -- Prices -- Periodicals; Investments -- Valuation -- Periodicals; Finance -- Periodicals; 332.632042
• DOI: 10.1093/rapstu/rax019
• Languages: English
• ISSNs: 2045-9939

Abstract

Abstract: A stylized theoretical model with stochastic volatility suggests the existence of a trade-off between returns and volatility-of-volatility. Using the VVIX, a measure of the option-implied volatility of the volatility index, we confirm this prediction and detect that time-varying aggregate volatility-of-volatility commands an economically substantial and statistically significant negative risk premium. We find that a two-standard-deviation increase in aggregate volatility-of-volatility factor loadings is associated with a decrease in average annual returns of about 11%. These results are robust to controlling for aggregate volatility, jump risk, and several other characteristics and factor sensitivities, as well as various additional tests. Received September 05, 2016; accepted June 21, 2017 by Editor Raman Uppal