Is the VRP Still the Same Risk Premium?

The volatility risk premium (VRP) is the difference between implied volatility and subsequently realized volatility, reflecting the compensation investors pay for volatility insurance. It has long been held that the VRP is generally negative for option buyers and positive for option sellers. However, market dynamics and regimes evolve over time, and the VRP should evolve as well. Recent studies have begun examining how changes in market structure, such as the growth of overnight trading, have affected the VRP.

Reference [1] takes this line of research further by conducting a broad examination of the VRP and its evolution over time. The study analyzes S&P 500 option returns from 1987 to 2025, including 95% out-of-the-money puts, ATM straddles, delta-hedged strategies, and variance-swap/VIX-based strategies.

The authors pointed out,

The conventional wisdom in asset pricing is that there is a large variance risk premium for the S&P 500 – larger than can be accounted for by exposure to the market alone, and that options earn large negative alphas because they are exposed to volatility and jump risk. This paper replicates past findings that options historically earned negative returns and CAPM alphas, but since around 2012 there is no longer evidence for those negative premia.

Though the paper does not go into great depth on the theory side, it does offer an explanation, which is that the decline in SPX options premia can be explained by declining asymmetry in dealer portfolios and the hedging costs they face.

…the results documented here should perhaps not be puzzling at all – they are just one more example of the performance of a trading strategy decaying after it is announced in a finance journal. That is a good thing: markets are getting more efficient. At a deep level, the implication of the results is that now it is much less expensive for investors to hedge deep losses in the aggregate stock market than it used to be.

In short, the paper identifies a structural break around 2012 using multiple break-detection tests. The authors argue that this shift coincided with important changes in market structure, such as the fact that retail investors became increasingly able to sell options, reducing persistent option overpricing, while dealer positioning moved from net short-option exposure toward a more neutral stance. Furthermore, declining dealer hedging frictions, such as bid-ask spreads and basis risk, are also consistent with lower volatility risk premia.

This is a timely and insightful paper that reinforces a broader theme: market and volatility dynamics are changing, and market participants must adapt accordingly.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Dew-Becker, I., & Stefano Giglio. The Decline of the S&P 500 Variance Risk Premium. Working paper, June 2026.

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