Expected Stock Returns and Variance Risk Premia

Tim Bollerslev (), Tzuo Hao and George Tauchen ()
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George Tauchen: School of Economics and Management, University of Aarhus, Denmark and CREATES, Postal: 8000 Aarhus C, Denmark

CREATES Research Papers from School of Economics and Management, University of Aarhus

Abstract: Motivated by the implications from a stylized self-contained general equilibrium model incorporating the effects of time-varying economic uncertainty, we show that the difference between implied and realized variation, or the variance risk premium, is able to explain a non-trivial fraction of the time series variation in post 1990 aggregate stock market returns, with high (low) premia predicting high (low) future returns. Our empirical results depend crucially on the use of “model-free,” as opposed to Black- Scholes, options implied volatilities, along with accurate realized variation measures constructed from high-frequency intraday, as opposed to daily, data. The magnitude of the predictability is particularly strong at the intermediate quarterly return horizon, where it dominates that afforded by other popular predictor variables, like the P/E ratio, the default spread, and the consumption-wealth ratio (CAY).

Keywords: Equilibrium asset pricing; stochastic volatility; risk neutral expectation; return predictability; option implied volatility; realized volatility; variance risk premium (search for similar items in EconPapers)
JEL-codes: C22 C51 C52 G12 G13 G14 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-fmk, nep-mst and nep-rmg
Date: 2008-09-03
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ftp://ftp.econ.au.dk/creates/rp/08/rp08_48.pdf (application/pdf)

Related works:
Working Paper: Expected stock returns and variance risk premia (2006)
Working Paper: Expected Stock Returns and Variance Risk Premia (2007)
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Persistent link: http://EconPapers.repec.org/RePEc:aah:create:2008-48

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