Ian Martin (Stanford GSB)

The events of 2008–9 disrupted volatility derivatives markets and caused the single-name variance swap market to dry up completely; it has never recovered. This paper introduces the simple variance swap, a more robust relative of the variance swap that can be priced and hedged even if the underlying asset’s price can jump, and constructs SVIX, an index based on simple variance swaps that measures market volatility. SVIX is consistently lower than VIX in the time series, which rules out the possibility that the market return and stochastic discount factor are conditionally lognormal. The SVIX index points to an equity premium that—in contrast to the prevailing view in the literature—is extraordinarily volatile and that spiked dramatically at the height of the recent crisis.