Faculty of Economics and Business Administration Publications Database

Volatility-of-Volatility Risk

Huang, Darien
Shaliastovich, Ivan
Thimme, Julian
Volume: 54
Number: 6
Pages: 2423 - 2452
Month: December
ISSN-Print: 0022-1090
Link External Source: Online Version
Year: 2019

We show that market volatility of volatility is a significant risk factor that affects index and volatility index option returns, beyond volatility itself. The volatility and volatility of volatility indices, identified model-free as the VIX and VVIX, respectively, are only weakly related to each other. Delta-hedged index and VIX option returns are negative on average and are more negative for strategies that are more exposed to volatility and volatility-of-volatility risks. Further, volatility and volatility of volatility significantly negatively predict future delta-hedged option payoffs. The evidence suggests that volatility and volatility-of-volatility risks are jointly priced and have negative market prices of risk.