The Variance Risk Premium: Components, Term Structures, and Stock Return Predictability

Junye Li and Gabriele Zinna

Journal of Business & Economic Statistics, 2018, vol. 36, issue 3, 411-425

Abstract: This article examines the properties of the variance risk premium (VRP). We propose a flexible asset pricing model that captures co-jumps in prices and volatility, and self-exciting jump clustering. We estimate the model on equity returns and variance swap rates at different horizons. The total VRP is negative and has a downward-sloping term structure, while its jump component displays an upward-sloping term structure. The abrupt and persistent response of the short-term jump VRP to extreme events makes this specific premium a proxy for investors’ fear of a market crash. Furthermore, the use of the VRP level and slope, and of its components, helps improve the short-run predictability of equity excess returns.

Date: 2018
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Citations: View citations in EconPapers (26)

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DOI: 10.1080/07350015.2016.1191502

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