Volatility Duration and the Early Resolution Premium

Category: Finance Brown Bag Seminar
When: 11 Januar 2017
, 02:00
 - 03:00
Where: HoF E.01
Speaker: Rüdiger Weber

Authors: Christian Schlag (Goethe University), Julian Thimme (Goethe University), Rüdiger Weber
(Goethe University)

Title: Volatility Duration and the Early Resolution Premium

Abstract:

We introduce Implied Volatility Duration (IVD) as a new measure for the timing of the resolution of uncertainty about a stock's cash flows. The shorter the IVD, the earlier the resolution of uncertainty. Portfolio sorts indicate that investors demand on average about seven percent return per year in exchange for a late resolution of uncertainty, and this premium cannot be explained by standard factor models. We find that the premium is higher in times of increased economic uncertainty and low market returns. We show in a general equilibrium model that the expected excess returns on high IVD stocks exceed those of low IVD stocks if and only if the investor's relative risk aversion exceeds the inverse of her elasticity of intertemporal substitution, i.e., if she exhibits  a “preference for early resolution of uncertainty” in the spirit of Epstein and Zin (1989). Our empirical analysis thus provides a purely market-based assessment of the relation between two preference parameters, which are usually hard to estimate.

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