Chayawat Ornthanalai

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Discussion
August 21st, 2009 EFA Conference, Bergen,
Norway
When Uncertainty Blows in the Orchard Comovement
and Volatility Risk Premia
Andrea Buraschi, Fabio Trojani and Andrea Vedolin
Discussion by

• Chayawat Ornthanalai

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What this paper shows

• Disagreement among investors generates the
  empirically observed variance and correlation
  risk premia
• Disagreement among investors can explain the
  differential price structure among index and
  individual equity options
• Index options have higher variance risk premium
  than those of individual equities
• Firm with higher disagreement among investors
  will be more negatively skewed and have higher
  variance risk premium
• Differences of opinion among investors matter !
  --- the common disagreement risk is a priced
  factor

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How did they do it?
Theoretically

• Solving for the equilibrium security prices
• Two firms, two agents, different beliefs
• Agents beliefs (priors) are updated according
  to Bayes law
• Agents disagree on
• (1) the dividend growth rate of each firm
• (2) the market-wide factor
• See also Buraschi and Jiltsov (JF, 06),
  Buraschi, Trojani and Vedolin (08)

Empirically

• Panel regressions
• Option trading strategies

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Variance Risk Premium Evidence
SP 500 index
Average of 30 large stocks
Why is it important to understand this phenomenon?
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Explaining Variance Risk Premium Cross-Section
Explanations for Cross-Sectional differences

• Why individual equity options are priced
  differently in the cross section ?
• Bollen and Whaley (JF, 04), Duan and Wei (RFS
  08), Garleanu, Pedersen and Poteshman (RFS 09),
  Elkamhi and Ornthanalai (09)

This paper

• 2) Why individual equity and index options are
  priced differently?
• Driessen, Maenhout and Vilkov (JF, 08)

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Explaining Index Variance Risk Premium
Time-Series
Why ?
Time-varying Index Variance Risk Premium
Driessen, Maenhout and Vilkov (JF 09)
Time-varying Correlation Risk Premium
Buraschi, Trojani and Vedolin (09)
Fluctuations of Disagreement Among investors
Investors pay attention to different signals
about the market condition at different times
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Investors attention and VRP

• In this paper, the common market risk factor
• Captures the business cycle/business condition
• Investors draw conclusions on this factor from

• The cross-section of firm-specific signals
• The market-wide signal

The model predicts that

• If investors put more weight on the market-wide
  signal, then the VRP will be lower, and vice
  versa.

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Investors are faced with limited attention

• Especially after macroeconomic shocks ? they
  shift their focus to market-wide signal
• See Peng and Xiong (JFE,06), and Peng Xiong and
  Bollerslev (EFM, 07)

WorldCom etc.
9/11
Asian Crisis
Dot-com bubble
LTCM
Enron
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Further comments

• Focus more on the implications of the model and
  reduce some of empirically contents
• Can the framework produce positive VRP?
• Writing Some housekeeping
• Panel regression for the skewness? Does it hold
  empirically?
• What insights does the model have on return
  predictability?