The Uncertainty of Risk - Volatility of Volatility in the Swedish Equity Market

Abstract: In addition to market volatility, a stylized theoretical model and recent empirical findings suggests the existence of a premium for market volatility of volatility. By developing seven different measures of volatility of volatility and through the method of principal component analysis, we investigate if this aggregate uncertainty is priced in the Swedish equity market. We find no strong evidence for a volatility of volatility effect in the cross-section of stock returns. Moreover, we find no persistence in stock exposure to volatility of volatility over time. This suggests that investors are unable to distinguish high volatility of volatility from low volatility of volatility stocks and hence, they cannot adequately price the aggregate market uncertainty in the Swedish equity market.