The volatility risk premium (VRP) represents the compensation that investors earn for providing protection against unexpected market volatility. This paper first describes the VRP and the reasons why it may exist. We then explore its historical performance with a simple option-selling strategy and conclude by discussing approaches for including it in a portfolio.
The VRP is the compensation that investors earn for providing protection against market losses. In doing so, they are underwriting insurance — primarily option contracts — and as with all insurance, the underwriter seeks a risk premium. We show that the VRP has historically tended to deliver strong risk-adjusted returns and that it may provide useful diversification within an investor’s portfolio. Interested investors could consider adding the strategy alongside traditional long-only strategies or use it in conjunction with other non-traditional return sources.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.