Expected Stock Returns and Variance Risk Premia

Tim Bollerslev and Hao Zhou

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: We find that the difference between implied and realized variation, or the variance risk premium, is able to explain more than fifteen percent of the ex-post time series variation in quarterly excess returns on the market portfolio over the 1990 to 2005 sample period, with high (low) premia predicting high (low) future returns. The magnitude of the return predictability of the variance risk premium easily dominates that afforded by standard predictor variables like the P/E ratio, the dividend yield, the default spread, and the consumption-wealth ratio (CAY). Moreover, combining the variance risk premium with the P/E ratio results in an R2 for the quarterly returns of more than twenty-five percent. The results depend crucially on the use of “model-free”, as opposed to standard Black-Scholes, implied variances, and realized variances constructed from high-frequency intraday, as opposed to daily, data. Our findings suggest that temporal variation in both risk-aversion and volatility-risk play an important role in determining stock market returns.

Keywords: Return Predictability; Implied Variance; Realized Variance; Equity Risk Premium; Variance Risk Premium; Time-Varying Risk Aversion (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Pages: 36
Date: 2007-08-16
New Economics Papers: this item is included in nep-bec, nep-ets, nep-mst and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (30)

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Related works:
Journal Article: Expected Stock Returns and Variance Risk Premia (2009)
Working Paper: Expected Stock Returns and Variance Risk Premia (2008)
Working Paper: Expected stock returns and variance risk premia (2006)
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2007-17

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