Volatility
Paper Session
Sunday, Jan. 8, 2017 3:15 PM – 5:15 PM
Sheraton Grand Chicago, Sheraton Ballroom V
- Chair: Ian Dew-Becker, Northwestern University
Oil Volatility Risk
Abstract
In the data, an increase in oil price volatility dampens current and future output, investment, employment, and consumption, controlling for market volatility and other business cycle variables. High oil uncertainty negatively affects equity prices, with a much more pronounced impact in durable industries. We develop a two-sector production model to explain the novel evidence in the data. In the model, oil is an essential input for production and can be stored. At times of high oil volatility, oil suppliers increase oil inventories and curb oil supply to the market. As a result, investment, production, and consumption go down, and oil inventories go up. These mechanisms are directly supported in the data.Weighted Least Squares Estimates of Return Predictability Regressions
Abstract
Time varying volatility causes substantial heteroskedasticity in return predictability regressions, making OLS estimates less efficient than least squares estimates weighted by ex-ante return variance (WLS-EV). In small sample simulations, I show that using WLS-EV instead of OLS results in large efficiency gains, fewer false negatives, and avoids the bias associated with ex-post weighting schemes. Using WLS-EV changes several important conclusions based on OLS estimates: traditional predictors such as the dividend-to-price ratio perform better in- and out-of-sample, whereas WLS-EV estimates of the predictability afforded by the variance risk premium, politics, the weather, and the stars are not significant.Variance Risk Premia on Stocks and Bonds
Abstract
Investors in fixed income markets are willing to pay a large premium to be hedged against shocks in expected volatility and the size of this premium can be studied through variance swaps. Using thirty years of options and high-frequency futures data we document the following novel stylized facts: First, exposure to bond market volatility is strongly priced with an annualized Sharpe ratio of -1.8, 20% higher than what is observed in the equity market. Second, while there is strong co-movement between equity and bond market variance risk, there are distinct periods when the bond variance risk premium is different from the equity variance risk premium. Third, the conditional correlation between stock and bond market variance risk premia switches sign often and ranges between -45% and +90%. Finally, variance risk premia on Treasuries predict positive expected bond returns but negative equity returns, and this finding is robust to the inclusion of theequity variance risk premium. We conclude by showing facts pose a serious challenge to consumption-based asset pricing models.
Discussant(s)
Torben Andersen
, Northwestern University
Kyle Jurado
, Duke University
Rasmus Tangsgaard Varneskov
, Northwestern University
Anh Le
, Pennsylvania State University
JEL Classifications
- G1 - Asset Markets and Pricing