[POSTPONED] Andrea Buffa (University of Colorado at Boulder)

Volatility Disagreement and Asset Prices

Abstract: We develop a dynamic equilibrium model in which investors disagree on future volatility and trade volatility derivatives to hedge their stock positions and speculate on their beliefs. Volatility disagreement makes the variance risk premium more negative on average, but when the market tends to underestimate future volatility, it becomes positive. This happens because volatility trading enables a risk transfer among investors with different expectations. In equilibrium, investors trade less volatility derivatives in more volatile periods, and may also do so when they disagree more, as these derivatives become too risky to hold. Volatility disagreement lowers the stock market, increases market volatility, and generates time-variation in the leverage effect. Our theory is able to reconcile key empirical findings observed during market turmoils.