Laeding and Following Variance Risk Premiums: Evidence from S&P500 and KOSPI200 Options

Abstract

This study aims to examine the return predictability of variance risk premium, which is defined as the difference between risk-neutral variance and expected realized variance, on KOSPI 200 index returns. Although extant literature shows that variance risk premium estimated from U.S. index options has a predictive power on underlying returns, little study has been conducted in KOSPI 200 index returns. In addition, there is no conclusion for the predictive power of variance risk premium in other financial markets. In this paper, we can find the predictive power of S&P500 variance risk premium on KOSPI200 index returns as well as on S&P500 index returns, but cannot find the predictive power of KOSPI200 variance risk premium on both indices. These results are consistent to Londono (2012) and Bollerslev et al. (2013). The poor performance of KOSPI200 variance risk premium is explained by the assumption that U.S. economy is a leader economy, while Korea economy is a follower economy. To support this conclusion, we conduct Vector Auto-Regression (VAR) using two variance risk premiums. Two premiums have bi-directional lead-lag relationship but S&P500 variance risk premium is informationally superior to KOSPI200 variance risk premium regarding return predictions.

Citation

Yoon, S.-J. and Kim, J.S. (2014), "Laeding and Following Variance Risk Premiums: Evidence from S&P500 and KOSPI200 Options", Journal of Derivatives and Quantitative Studies: 선물연구, Vol. 22 No. 1, pp. 45-70. https://doi.org/10.1108/JDQS-01-2014-B0003