Expected stock returns and variance risk premia

Tim Bollerslev () and Hao Zhou ()

No 2007-11, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We find that the difference between implied and realized variances, 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 R^2 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 risk and risk-aversion both play an important role in determining stock market returns.

Keywords: Financial risk management; Stock price forecasting (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk, nep-rmg and nep-upt
Date: 2006
View list of references View citations in EconPapers

Downloads: (external link)
http://www.federalreserve.gov/pubs/feds/2007/200711/200711abs.html (text/html)
http://www.federalreserve.gov/pubs/feds/2007/200711/200711pap.pdf (application/pdf)

Related works:
Working Paper: Expected Stock Returns and Variance Risk Premia (2007)
Working Paper: Expected Stock Returns and Variance Risk Premia (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:fip:fedgfe:2007-11

Ordering information: This working paper can be ordered from
http://www.federalre ... /feds/fedsorder.html

Access Statistics for this paper

More papers in Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)
Contact information at EDIRC.
Series data maintained by Diane Rosenberger ().