Rights statement: This is the author’s version of a work that was accepted for publication in International Review of Financial Analysis. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International Review of Financial Analysis, 86, 2023 DOI: 10.1016/j.irfa.2023.102507
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Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
}
TY - JOUR
T1 - On the Right Jump Tail Inferred from the VIX Market
AU - Li, Zhenxiong
AU - Yao, Xingzhi
AU - Izzeldin, Marwan
N1 - This is the author’s version of a work that was accepted for publication in International Review of Financial Analysis. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International Review of Financial Analysis, 86, 2023 DOI: 10.1016/j.irfa.2023.102507
PY - 2023/3/31
Y1 - 2023/3/31
N2 - This paper addresses the role of the right jump tail under the risk-neutral measure, as a proxy for fear-of-fear, in the return predictability implicit in the VIX market. A simulation establishes that the right jump tail dominates the left jump tail in explaining various risk measures and their associated term structures. Using VIX futures and options from 2006 until 2020, the superior predictive power for futures returns afforded by the variance-of-variance risk premium (V V RP) is shown to arise predominantly from the right jump tail risk. A separate consideration of the continuous and jump tail components of the V V RP outperforms the alternative models in an out-of-sample forecasting exercise and generates non-trivial economic value, especially over short horizons. However, the impact of right jump tail is weak on option returns and only evident for short maturities, suggesting that the fear component cannot be the sole factor explaining the observed losses incurred on the delta-hedged VIX options.
AB - This paper addresses the role of the right jump tail under the risk-neutral measure, as a proxy for fear-of-fear, in the return predictability implicit in the VIX market. A simulation establishes that the right jump tail dominates the left jump tail in explaining various risk measures and their associated term structures. Using VIX futures and options from 2006 until 2020, the superior predictive power for futures returns afforded by the variance-of-variance risk premium (V V RP) is shown to arise predominantly from the right jump tail risk. A separate consideration of the continuous and jump tail components of the V V RP outperforms the alternative models in an out-of-sample forecasting exercise and generates non-trivial economic value, especially over short horizons. However, the impact of right jump tail is weak on option returns and only evident for short maturities, suggesting that the fear component cannot be the sole factor explaining the observed losses incurred on the delta-hedged VIX options.
KW - Jump tail risk
KW - return predictability
KW - variance risk premium
KW - VIX derivatives
U2 - 10.1016/j.irfa.2023.102507
DO - 10.1016/j.irfa.2023.102507
M3 - Journal article
VL - 86
JO - International Review of Financial Analysis
JF - International Review of Financial Analysis
SN - 1057-5219
M1 - 102507
ER -