A non-linear dynamic model of the variance risk premium

Bjørn Eraker and Jiakou Wang

Journal of Econometrics, 2015, vol. 187, issue 2, 547-556

Abstract: We propose a new class of non-linear diffusion processes for modeling financial markets data. Our non-linear diffusions are obtained as transformations of affine processes. We show that asset-pricing and estimation is possible and likelihood estimation is straightforward. We estimate a non-linear diffusion model for the VIX index under both the objective measure and the risk-neutral measure where the latter is obtained from futures prices. We find evidence of significant non-linearity under both measures. We define the difference between the P and Q drift as a measure of the variance risk premium and show that it has strong predictive power for stock returns.

Keywords: VIX; Semi-nonparametric diffusion; VIX futures; GMM; MLE; Non-linear asset pricing (search for similar items in EconPapers)
JEL-codes: C58 G13 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:187:y:2015:i:2:p:547-556

DOI: 10.1016/j.jeconom.2015.02.038

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