Modelling the variance risk premium of equity indices: the role of dependence and contagion

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Title: Modelling the variance risk premium of equity indices: the role of dependence and contagion
Authors: Granelli, A
Veraart, A
Item Type: Journal Article
Abstract: The variance risk premium (VRP) refers to the premium demanded for holding assets whose variance is exposed to stochastic shocks. This paper identifies a new modelling framework for equity indices and presents for the first time explicit analytical formulas for their VRP in a multivariate stochastic volatility setting, which includes multivariate non-Gaussian Ornstein-Uhlenbeck processes and Wishart processes. Moreover, we propose to incorporate contagion within the equity index via a multivariate Hawkes process and find that the resulting dynamics of the VRP represent a convincing alternative to the models studied in the literature up to date. We show that our new model can explain the key stylised facts of both equity indices and individual assets and their corresponding VRP, while some popular (multivariate) stochastic volatility models may fail.
Issue Date: 14-Jun-2016
Date of Acceptance: 11-Apr-2016
ISSN: 1945-497X
Publisher: Society for Industrial and Applied Mathematics
Start Page: 382
End Page: 417
Journal / Book Title: SIAM Journal on Financial Mathematics
Volume: 7
Issue: 1
Copyright Statement: © 2016, Society for Industrial and Applied Mathematics
Sponsor/Funder: Commission of the European Communities
Funder's Grant Number: FP7-PEOPLE-2012-CIG-321707
Keywords: 0102 Applied Mathematics
Publication Status: Published
Appears in Collections:Mathematics
Faculty of Natural Sciences

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