Variance Risk Premia in Energy Commodities

Journal of Derivatives, vol. 17, p. 15-32, 2010, https://doi.org/10.3905/jod.2010.17.3.015

Posted: 15 Jul 2008 Last revised: 21 May 2019

See all articles by Anders B. Trolle

Anders B. Trolle

Copenhagen Business School

Eduardo S. Schwartz

University of California, Los Angeles (UCLA) - Finance Area; Simon Fraser University (SFU); National Bureau of Economic Research (NBER)

Date Written: July 15, 2008

Abstract

This paper investigates variance risk premia in energy commodities, particularly crude oil and natural gas, using a robust model-independent approach. Over a period of 11 years, we find that the average variance risk premia are negative for both energy commodities. Energy variance risk premia in dollar terms are time-varying, while energy variance risk premia in return terms, particularly in the case of natural gas, are more constant over time. Finally, the return profile of a natural gas variance swap resembles that of a call option, while the return profile of a crude oil variance swap, if anything, resembles the return profile of a put option. The annualized Sharpe ratios from shorting energy variance are sizable. Although not nearly as high as the annualized Sharpe ratio of shorting S&P 500 index variance, they are comparable to those of shorting interest rate volatility or variance on individual stocks.

Keywords: Crude oil, natural gas, stochastic variance, risk premia

JEL Classification: G13

Suggested Citation

Trolle, Anders B. and Schwartz, Eduardo S. and Schwartz, Eduardo S., Variance Risk Premia in Energy Commodities (July 15, 2008). Journal of Derivatives, vol. 17, p. 15-32, 2010, https://doi.org/10.3905/jod.2010.17.3.015, Available at SSRN: https://ssrn.com/abstract=1160195 or http://dx.doi.org/10.2139/ssrn.1160195

Anders B. Trolle (Contact Author)

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Eduardo S. Schwartz

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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