Asymmetric Volatility Risk : Evidence from Option Markets

Abstract

Using non-parametric methods to model the dependencies between risk-neutral distributions of the market index (S&P 500) and its expected volatility (VIX), we show how to extract the expected risk-neutral correlation between the index and its future expected volatility. Comparing the implied correlation to its realized counterpart reveals a significant risk premium priced into the index-volatility correlation, which can be interpreted as the compensation for the fear of rising volatility during and after a market crash, i.e., fear of crash continuation for a prolonged period of time. We show how the index-volatility correlation premium is related to future market returns and explain its economics.