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The market price of risk of the variance term structure

George Dotsis

Journal of Banking & Finance, 2017, vol. 84, issue C, 41-52

Abstract: In this paper I examine the market price of risk of the variance term structure. To this end, the S&P 500 option implied variance term structure is used as a proxy for aggregate variance risk. Principal component analysis shows that time variation in the variance term structure over the 1996–2012 period can be explained mainly by two factors which capture changes in the level and slope. The market price of risk of each factor is estimated in the cross-section of stock returns. The slope of the variance term structure is the most significant factor in the cross-section of stocks returns and carries a negative risk premium. The slope factor has also some predictive ability over long horizon equity returns.

Keywords: Stochastic variance; Variance term structure; Cross-section of returns (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2017
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