The VIX Premium

TLDR

Ex‑ante estimates of the VIX premium fall or stay flat when risk rises, posing a puzzle for theories of volatility hedging. Falling hedging demand explains the behavior, with premiums and trader exposures falling together when risk rises, and the authors provide an Internet Appendix on the Oxford University Press website. Ex‑ante premiums reliably predict ex‑post VIX futures returns (coefficient ≈1) and, when falling, signal rising market and investment risk, offering profitable trading opportunities. Received January 13, 2017; editorial decision April 26, 2018 by Editor Stijn Van Nieuwerburgh.

Abstract

Ex ante estimates of the volatility premium embedded in VIX futures, known as the VIX premium, fall or stay flat when ex ante measures of risk rise. This is not an artifact of mismeasurement: (i) ex ante premiums reliably predict ex post returns to VIX futures with a coefficient near one, and (ii) falling ex ante premiums predict increasing ex post market and investment risk, creating profitable trading opportunities. Falling hedging demand helps explain this behavior, as premiums and trader exposures tend to fall together when risk rises. These facts provide a puzzle for theories of why investors hedge volatility. Received January 13, 2017; editorial decision April 26, 2018 by Editor Stijn Van Nieuwerburgh. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.