Downside Variance Risk Premium

Bruno Feunou, Mohammad Jahan-Parvar and Cedric Okou

No 2015-20, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We propose a new decomposition of the variance risk premium in terms of upside and downside variance risk premia. The difference between upside and downside variance risk premia is a measure of skewness risk premium. We establish that the downside variance risk premium is the main component of the variance risk premium, and that the skewness risk premium is a priced factor with significant prediction power for aggregate excess returns. Our empirical investigation highlights the positive and significant link between the downside variance risk premium and the equity premium, as well as a positive and significant relation between the skewness risk premium and the equity premium. Finally, we document the fact that the skewness risk premium fills the time gap between one quarter ahead predictability, delivered by the variance risk premium as a short term predictor of excess returns and traditional long term predictors such as price-dividend or price-earning ratios. Our resul ts are supported by a simple equilibrium consumption-based asset pricing model.

Keywords: Downside variance risk premium; realized volatility; risk-neutral volatility; skewness risk premium; upside variance risk premium (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 66 pages
Date: 2015-03-17
New Economics Papers: this item is included in nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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http://www.federalreserve.gov/econresdata/feds/2015/files/2015020pap.pdf Full text (application/pdf)
http://dx.doi.org/10.17016/FEDS.2015.020 http://dx.doi.org/10.17016/FEDS.2015.020 (application/pdf)

Related works:
Journal Article: Downside Variance Risk Premium (2018)
Working Paper: Downside Variance Risk Premium (2015)
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