Modeling Volatility Risk Premium
Posted: 24 Mar 2016
Date Written: February 23, 2016
Abstract
The bias between the expected realised variance under the historical measure and the risk neutral probability introduces the concept of the risk premium. How does the market variance risk premium vary over time or look like in the future? Our work introduced a probabilistic modeling of the variance risk premium (VRP) via a parametric stochastic volatility model. Our framework deals with the class of non-affine continuous time diffusions of the spot-variance process. We give a general backward stochastic representation of the VRP via some basis of Malliavin Calculus. We provide two applications: the first discusses an affine case of stochastic volatility model and the second models the VRP in the framework of the non-affine stochastic volatility model.
Keywords: Martingale, Malliavin, Risk premium
JEL Classification: C30, G17
Suggested Citation: Suggested Citation