The Profitability of Volatility Trading on Exchange-traded Dollar-rupee Options: Evidence of a Volatility Risk Premium?

This article examines the profitability of short volatility strategies in the exchange-traded USDINR options market. Returns from delta-hedged short positions in straddles, strangles and individual call and put options are examined across different trading horizons and volatility regimes. The study finds that short volatility strategies yield significant mean and median returns regardless of the trading horizon and option moneyness before considering transaction costs. This is suggestive of a volatility risk premium priced in USDINR options. However, the returns are found to be insignificant and even negative after accounting for trading costs such as bid-ask spreads and brokerage. The study concludes that although USDINR options appear to be overpriced because of the volatility risk premium, short option strategies can be profitably exploited only by market makers and institutional investors facing low spreads and funding costs. The findings are suggestive of an informationally efficient market.

Volatility Risk Pass-Through

We develop a novel measure of volatility pass-through to assess international propagation of output volatility shocks to macroeconomic aggregates, equity prices, and currencies. An increase in country’s output volatility is associated with a decrease in its output, consumption, and net exports. The average consumption pass-through is 50% (a 1% increase in output volatility increases consumption volatility by 0.5%) and it increases to 70% for shocks originating in smaller countries. The equity volatility pass-through is larger and in the order of 90%. A novel channel of risk sharing of volatility risks can explain our empirical findings.

Pricing the Volatility Risk Premium with a Discrete Stochastic Volatility Model

Investors’ decisions on capital markets depend on their anticipation and preferences about risk, and volatility is one of the most common measures of risk. This paper proposes a method of estimating the market price of volatility risk by incorporating both conditional heteroscedasticity and nonlinear effects in market returns, while accounting for asymmetric shocks. We develop a model that allows dynamic risk premiums for the underlying asset and for the volatility of the asset under the physical measure. Specifically, a nonlinear in mean time series model combining the asymmetric autoregressive conditional heteroscedastic model with leverage (NGARCH) is adapted for modeling return dynamics. The local risk-neutral valuation relationship is used to model investors’ preferences of volatility risk. The transition probabilities governing the evolution of the price of the underlying asset are adjusted for investors’ attitude towards risk, presenting the asset returns as a function of the risk premium. Numerical studies on asset return data show the significance of market shocks and levels of asymmetry in pricing the volatility risk. Estimated premiums could be used in option pricing models, turning options markets into volatility trading markets, and in measuring reactions to market shocks.

Assessing Investment in Ghana's Upstream Oil and Gas Industry: the Risk and Returns

The study sought to assess Investment in Ghana Upstream Sector, looking at the risk involved in the loss of Investment and the returns from the investment. The specific objectives were: to establish the level of investment in the oil and gas projects that are producing in commercial volumes in the Upstream sector of Ghana, to assess the revenues realized by Ghana and the IOCs from the sale of oil and gas since the start of commercial production in the year 2010. The researchers noticed that investors in the upstream sector face risk such as: price volatility risk, political risk, investment risk, and many other risks that affect the upstream operations. For the purposes of this study, risk is limited to investment risk. Thus, the researchers are looking at the level of investment in the upstream sector and whether the investment has any relation with the returns or revenues. A purposeful sampling technique was used to select the three commercial producing fields in Ghana for the Study. These are the Jubilee field, the TEN field, and the SGN field. Secondary data including oil and gas production volumes was taken from the annual reports of PIAC. Other secondary data was taken from Petroleum Commission, and Ministry of Finance. The results of the study showed that a total of about 8.8 billion US dollars was invested in the Jubilee field. About 4.998 billion US dollars and 5.2 billion US dollars was invested in TEN and SGN fields respectively. This means a total of about 19 billion US dollars was invested in the exploration and development of the three producing fields in Ghana. The results also indicated that despite all the risk in the upstream sector, about 22.69 billion US dollars revenues has been realized by the IOCs from the sale of oil and gas since the commencement of production in the year 2010. The results also showed that Ghana group realized about 4.98 billion US dollars from the revenues of oil and gas over the same period.