Expected Stock Returns and Variance Risk Premia

41 Pages Posted: 21 Sep 2006 Last revised: 14 Dec 2008

See all articles by Tim Bollerslev

Tim Bollerslev

Duke University - Finance; Duke University - Department of Economics; National Bureau of Economic Research (NBER)

George Tauchen

Duke University - Economics Group

Hao Zhou

Tsinghua University - PBC School of Finance; SUSTech Business School

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2008

Abstract

Motivated by the implications from a stylized self-contained general equilibrium model incorporating the effects of time-varying economic uncertainty, we show that the difference between implied and realized variation, or the variance risk premium, is able to explain a non-trivial fraction of the time series variation in post 1990 aggregate stock market returns, with high (low) premia predicting high (low) future returns. Our empirical results depend crucially on the use of "model-free,'' as opposed to Black-Scholes, options implied volatilities, along with accurate realized variation measures constructed from high-frequency intraday, as opposed to daily, data. The magnitude of the predictability is particularly strong at the intermediate quarterly return horizon, where it dominates that afforded by other popular predictor variables, like the P/E ratio, the default spread, and the consumption-wealth ratio (CAY).

Keywords: Equilibrium asset pricing, stochastic volatility, risk neutral expectation, return predictability, option implied volatility, realized volatility, variance risk premium

JEL Classification: C22, C51, C52, G12, G13, G14

Suggested Citation

Bollerslev, Tim and Tauchen, George E. and Zhou, Hao, Expected Stock Returns and Variance Risk Premia (July 1, 2008). AFA 2008 New Orleans Meetings Paper, Review of Financial Studies, Forthcoming, Duke Department of Economics Research Paper No. 5, CREATES Research Paper No. 2008-48, Available at SSRN: https://ssrn.com/abstract=948309 or http://dx.doi.org/10.2139/ssrn.948309

Tim Bollerslev

Duke University - Finance ( email )

Durham, NC 27708-0120
United States
919-660-1846 (Phone)
919-684-8974 (Fax)

Duke University - Department of Economics

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

George E. Tauchen

Duke University - Economics Group ( email )

Box 90097
221 Social Sciences
Durham, NC 27708-0097
United States
919-660-1812 (Phone)
919-684-8974 (Fax)

Hao Zhou (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing, 100083
China
+86-10-62790655 (Phone)

SUSTech Business School ( email )

1088 Xueyuan Avenue, Nanshan District
Southern University of Science and Technology
Shenzhen, Guangdong 518055
China

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