The volatility risk premium (VRP) has been studied extensively in the literature, especially in equities. However, little work has been done in the crypto space. Reference [1] fills this gap by investigating the Bitcoin return premium (BP) and the Bitcoin variance risk premium (BVRP).
The authors utilized Bitcoin options data traded on Deribit from July 2017 to December 2022 to calculate the BVRP. The implied variance is computed using the same methodology as the VIX index. Additionally, they derived risk-neutral densities (RNDs) from the option volatility surface and subsequently used RNDs to classify Bitcoin market states as high volatility or low volatility.
The authors pointed out,
The BP is significantly higher than that of traditional investment assets such as currencies, commodities, and stocks, averaging around 66% per year….The annualized risk-neutral and physical monthly variances, proxied by the squared Bitcoin Volatility Index (BVIX) and the realized variance (BRV), are significantly high: 0.72 and 0.58, respectively. The corresponding variance risk premium is 0.14, much higher than that of the S&P 500 Index—approximately 2%, according to Bollerslev, Tauchen, and Zhou (2009).
We further analyze conditional estimates across market regimes. Our results indicate that BP is higher in the HV regime... The overall increased volatility leads to higher option price premia on average across all moneyness levels. The variance under the two probability measures is quite different and introduces a substantial VRP in both market regimes. Surprisingly, the low volatility cluster is characterized by a higher VRP of 0.17 compared to the high volatility cluster of 0.12, suggesting a potential disconnect between variance and VRP. By relying on the average values of the premia within each cluster, we observe a negative relationship between the BP and BVRP in the Bitcoin market. This contrasts with the findings in S&P 500 Index market, where a positive relationship between variance risk premium and future returns has been reported by Bollerslev, Tauchen, and Zhou (2009) in a regression setup. Simultaneously, our clustering results indicate a positive relationship between returns and variance, supporting the inverse leverage effect in the Bitcoin market documented by Hou et al. (2020).
In short, the paper found that Bitcoin is far more volatile and exhibits a higher variance risk premium than the S&P 500, and that the Bitcoin return premium (BP) is also elevated. Risk premia vary over time as a function of two distinct volatility regimes.
This is an important contribution to the understanding of the crypto options market. However, the dataset extends only through 2022. Since then, Bitcoin has reached a broader user base, and its volatility dynamics have evolved. It would be interesting to examine whether the findings hold in the current market.
Let us know what you think in the comments below or in the discussion forum.
References
[1] Caio Almeida, Maria Grith, Ratmir Miftachov, Zijin Wang, Risk Premia in the Bitcoin Market, arXiv:2410.15195
Originally Published Here: Return and Variance Risk Premia in the Bitcoin Market
source https://harbourfronts.com/return-variance-risk-premia-bitcoin-market/
