Delta-Hedged Gains and the Negative Market Volatility Risk Premium

Posted: 10 Jan 2002

See all articles by Nikunj Kapadia

Nikunj Kapadia

University of Massachusetts Amherst - Department of Finance

Gurdip Bakshi

Temple University - Fox School of Business and Management; Fox School of Business

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Abstract

We investigate whether the volatility risk premium is negative by examining the statistical properties of delta-hedged option portfolios (buy the option and hedge with stock). Within a stochastic volatility framework, we demonstrate a correspondence between the sign and magnitude of the volatility risk premium, and the mean delta-hedged portfolio return. Using a sample of S&P 500 index options, we provide empirical tests that have the following general results. First, the delta-hedged strategy underperforms zero. Second, the documented underperformance is less for options away from the money. Third, the underperformance is greater at times of higher volatility. Fourth, the volatility risk premium significantly affects delta-hedged gains even after accounting for jump fears. Our evidence is supportive of a negative market volatility risk premium.

Keywords: Option pricing, stochastic volatility, volatility risk premium, delta-hedged gains

JEL Classification: G10, G12, G13

Suggested Citation

Kapadia, Nikunj and Bakshi, Gurdip S., Delta-Hedged Gains and the Negative Market Volatility Risk Premium. Available at SSRN: https://ssrn.com/abstract=293707

Nikunj Kapadia (Contact Author)

University of Massachusetts Amherst - Department of Finance ( email )

Amherst, MA 01003
United States
413-545-5643 (Phone)
413-545-5600 (Fax)

HOME PAGE: http://www-unix.oit.umass.edu/~nkapadia/

Gurdip S. Bakshi

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

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