Market Attitudes under Uncertainty: What is Priced in the Crude Oil Volatility Risk Premium?

Abstract

This paper studies the predictability of volatility risk premia in WTI crude oil futures markets under an uncertain environment. I find that a nontrivial fraction of the magnitude and the direction of the volatility risk premium can be explained by the unforeseeable fluctuations in macroeconomic and financial indicators. Although the previous literature has shown that most of the risk factors (for example, book-to-market ratio and momentum) used in capital asset pricing models are not responsible for variations in the volatility risk premium, I find evidence that the effects of some of the indicators like open interest momentum and growth rate of market interest could be enhanced when taking uncertainty into consideration. The effects of market participants’ behaviors and risk attitudes are strongly correlated with uncertainty, and the cost of hedging against futures price variance will increase if uncertainty in the macroeconomic environment is high.