Can tests based on option hedging errors correctly identify volatility risk premia?

  • Tests for the existence and the sign of the volatility risk premium are often based on expected option hedging errors. When the hedge is performed under the ideal conditions of continuous trading and correct model specification, the sign of the premium is the same as the sign of the mean hedging error for a large class of stochastic volatility option pricing models. We show, however, that the problems of discrete trading and model mis-specification, which are necessarily present in any empirical study, may cause the standard test to yield unreliable results.

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Author:Nicole BrangerORCiDGND, Christian SchlagORCiDGND
Parent Title (English):Universität Frankfurt am Main. Fachbereich Wirtschaftswissenschaften: [Working paper series / Finance and accounting] Working paper series, Finance & Accounting ; No. 136
Series (Serial Number):Working paper series / Johann-Wolfgang-Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften : Finance & Accounting (136, Versi)
Publisher:Univ., Fachbereich Wirtschaftswiss.
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2004
Year of first Publication:2004
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2005/10/06
Tag:Volatilität / Risikoprämie / Statistischer Test / Optionspreistheorie / Stochastischer Prozess / Theorie
Discretization Error; Model Error; Stochastic Volatility; Volatility Risk Premium
GND Keyword:Volatilität; Hedging
Issue:version: May 24, 2004
Page Number:47
This paper was formerly titled 'Is Volatility Risk Priced? | Properties of Tests Based on Option
Hedging Errors'. Earlier versions were presented at Arizona State University, at the 35th Annual Meeting of the Money, Macro, and Finance Research Group conference in Cambridge, at the EIASM Workshop on Dynamic Strategies in Asset Allocation and Risk Management in Brussels, at the 2003 annual congress of the Verein für Socialpolitik in Zurich, at the 10th Annual Meeting of the German Finance Association in Mainz, at the annual meetings of European Investment Review in Geneva, and at the 2003 MathFinance Colloquium in Frankfurt.
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht