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How aggregate volatility-of-volatility affects stock returns

Hollstein, F. and Prokopczuk, M. (2017) How aggregate volatility-of-volatility affects stock returns. The Review of Asset Pricing Studies. ISSN 2045-9939 (In Press)

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To link to this item DOI: 10.1093/rapstu/rax019

Abstract/Summary

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.

Item Type:Article
Refereed:Yes
Divisions:Henley Business School > ICMA Centre
ID Code:75564
Publisher:Society for Financial Studies

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