National Pingtung University of Science and Technology,I-Shou University,National Changhua University of Education
Abstract:
Volatility risk premiums are defined as the departure between physical and risk-neutral volatilities. The theory of Bakshi and Madan (2006) identifies the extent of investors’ risk aversion and skewness and kurtosis of the physical volatility as determinants of volatility risk premiums and predicts negative volatility risk premiums when a physical index distribution has fatter left-tails. This study empirically examines the theory of Bakshi and Madan (2006) using TAIEX index returns and options on TAIEX index. We employ Black-Scholes implied volatility and model-free volatility to measure the risk-neutral volatility and use three methods to calculate the physical volatility. Our evidence shows that volatility risk premiums of TAIEX index are significantly negative. We also find that after July 2007, fatter right-tails of the physical distribution of TAIEX index turn to fatter left-tails and absolute values of its volatility risk premiums significantly drop down. These findings suggest that besides the factors suggested by Bakshi and Madan (2006), there are some other factors that affect volatility risk premiums and need to be further identified by future research.
