DP20834 Equilibrium VIX in Inelastic Markets
On average, the squared VIX exceeds realized variance. This implies that investors pay a premium to hold variance risk. But, why *pay* for risk? And, why does the premium correlate with volume? In Grossman-Miller type inelastic markets, investors hold variance risk to hedge against liquidity shocks, because these shocks cause price pressures that add to realized variance. Therefore, a positive variance risk premium must emerge in equilibrium. This result is developed formally, and the model is calibrated to match empirical patterns in the variance risk premium and trading volume around eleven crises between 1993 and 2025.
Citation
Menkveld, A (2025), ‘DP20834 Equilibrium VIX in Inelastic Markets‘, CEPR Discussion Paper No. 20834. CEPR Press, Paris & London. https://cepr.org/publications/dp20834