Market prices reflect large risk premium for variance trading strategy.
The article introduces a new method for trading variance, showing how to replicate realized variance even when prices jump. By sticking to a specific rebalancing schedule, errors in hedging can be minimized. Analyzing S&P 500 data from 1990 to 2009, the study reveals that market variance risk is priced with a large negative risk premium. This premium cannot be explained by known risk factors or option returns.