Variance Risk Premia on Stocks and Bonds

Petar Sabtchevsky, Paul Whelan, Andrea Vedolin and Philippe Mueller (philippe.mueller@wbs.ac.uk)
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Petar Sabtchevsky: London School of Economics
Paul Whelan: Copenhagen Business School
Andrea Vedolin: London School of Economics

No 1161, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: We study equity (EVRP) and Treasury variance risk premia (TVRP) jointly and document a number of findings: First, relative to their volatility, TVRP are comparable in magnitude to EVRP. Second, while there is mild positive co-movement between EVRP and TVRP unconditionally, time series estimates of correlation display distinct spikes in both directions and have been notably volatile since the financial crisis. Third $(i)$ short maturity TVRP predict excess returns on short maturity bonds; $(ii)$ long maturity TVRP and EVRP predict excess returns on long maturity bonds; and $(iii)$ while EVRP predict equity returns for horizons up to 6-months, long maturity TVRP contain robust information for long run equity returns. Finally, exploiting the dynamics of real and nominal Treasuries we document that short maturity break-even rates are a power determinant of the joint dynamics of EVRP, TVRP and their co-movement. We argue this result is consistent with an economy in which derivative markets embed fears about deflation.

Date: 2017
New Economics Papers: this item is included in nep-rmg
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