While investors tend to be familiar with risk premium concepts related to equity, credit and liquidity, the concept of volatility risk premium tends to be less acknowledged. Volatility trading instruments and products can be traded within several asset classes such as equities, bonds and currencies. In addition, their trading volumes have grown significantly over the past 30 years.
This paper explains the fundamental rationale behind volatility risk premia, the investment outcomes sought from extracting equity volatility risk premium, and shows how the volatility risk premium extraction can be used to improve the investment outcome of a typical diversified fund.
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