Implied Volatility Duration and the Early Resolution Premium

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We introduce Implied Volatility Duration (IVD) as a new measure for the timing of the resolution of uncertainty, with a high IVD indicating late resolution. Portfolio sorts on a large cross-section of stocks indicate that investors demand on average about seven percent return per year as a compensation for a late resolution of uncertainty. This premium is higher in times of increased economic uncertainty and low market returns and cannot be explained by standard factor models. In a general equilibrium model, we show that the expected excess return differential between 'late' and 'early' stocks can only be positive, if the investor's relative risk aversion exceeds the inverse of her elasticity of intertemporal substitution, i.e., if she exhibits a preference for early resolution of uncertainty in the spirit of Epstein and Zin (1989). Our empirical analysis thus provides a purely market-based assessment of the relation between two preference parameters, which are notoriously hard to estimate.

Author(s):

Christian Schlag    
Goethe University Frankfurt
Germany

Julian Thimme    
Goethe University Frankfurt
Germany

Rüdiger Weber    
Goethe University Frankfurt
Germany