Volatility-of-Volatility Risk in Asset Pricing
74 Pages Posted: 27 Feb 2021
Date Written: December 16, 2020
This paper develops a general equilibrium model and provides empirical support that the market volatility-of-volatility (VOV) predicts market returns and drives the time-varying volatility risk. In asset pricing tests with the market, volatility and VOV as factors, the risk premium on VOV is statistically and economically significant and robust. The market risk and volatility risk are not priced in unconditional models but, consistent with theory, their factor loadings conditional on VOV are priced. The pricing impact of VOV strengthens during market crashes suggesting that VOV is particularly relevant during market turmoil when investors’ demand for compensation for VOV risk strengthens.
Keywords: Volatility-of-Volatility, Volatility Risk, Conditional Asset Pricing Model, Market Crashes
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation