An Asset Class Characterization of the U.S. Equity Index Volatility Risk Premium

Abstract

The authors use a novel 32-year return series to study the risk, return, and predictability of a strategy that sells one-month S&P 500 variance swaps with fixed ex-ante tail risk. They find that unconditional short exposure in their sample is characterized primarily by two features: (1) a very high Sharpe ratio exceeding 1.2 and (2) a severe but infrequent crash risk. From a forecasting perspective, the authors find a generally lower premium following market sell-offs and crashes. However, they fail to find significant evidence linking returns to the level of either implied or realized volatility.