A Study of Volatility Risk

Time variations of market volatility considerably affect investments risk evaluation and prediction of future returns. They are presented as a source of systemic risk to which is added a risk related to stocks’ sensitivity to volatility shocks. Analysis of the relationship between stocks volatility and market volatility allows for determining whether stocks’ sensitivities to volatility shocks may estimate market’s future risk price. Volatility shocks are defined in terms of volatility risk hedging factors, when market volatility risk price is high and for stocks that are positively correlated to these hedging factors, the value of returns is expected to be low. Idiosyncratic volatility is on the other hand a variable omitted from volatility total risk. If market volatility risk is a missing component of systematic risk, standard models should mis-price portfolios sorted by idiosyncratic volatility because these models do not include factor loadings measuring exposure to market volatility risk.