Global contagion of volatilities and volatility risk premiums

This paper proposes a method for measuring volatility risk premiums using option prices and high-frequency intra-day price data, which then apply to stock indices in Japan, Europe, and the US. The paper also investigates how volatilities and volatility risk premiums propagate among the markets and how the interdependency through the propagation changes during the course of the global financial market turmoil after the summer of 2007. Our studies reveal that the return shocks and the successive increases in volatilities and the volatility risk premiums evolved through global equity markets. Specifically, we identify i) our estimate of the volatility risk premiums show stronger correlation with market risk indicators than those reported in earlier studies, ii) the positive spillover effects among equity returns remain positive with additional counter feedback to the US market during the turmoil, iii) the volatility shows strong reciprocal dependency among the three markets after the Lehman Brothers bankruptcy. As for the contagion of volatility risk premiums, iv) while the interdependency is weakened after the summer of 2007, it grows stronger after the Lehman Brothers bankruptcy in most of the directions, particularly from Europe to US.