volatility risk premium in stochastic volatility model

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pwyborn
Posts: 25
Joined: Sat Oct 29, 2011 12:42 pm

volatility risk premium in stochastic volatility model

Postby pwyborn » Wed Jun 12, 2013 4:01 pm

Hi Carol,

The volatility risk premium inserted in the PDE for stochastic volatility model is risk compensation for bearing the entirety of volatility risk? ie. is it for bearing the risk associated with dW2? But why? since volatility and price are correlated, at the end of the day, it is the part of the total risk of volatility AND price risk which cannot be completed or hedged away which is borne by investors, therefore risk premium should be for this uncompleted part of risk?

Could you clarify?

Thanks

pete
l

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