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Abstract:
Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cashflow risk manifest themselves in asset prices. We demonstrate that the variance premium, defined as the difference between the squared VIX index and expected realized variance, captures attitudes toward uncertainty. We show conditions under which the variance premium displays significant time variation and return predictability. A calibrated, generalized Long-Run Risks model generates a variance premium with time variation and return predictability that is consistent with the data, while simultaneously matching the levels and volatilities of the market return and risk free rate. Our evidence indicates an important role for transient non-Gaussian shocks to fundamentals that affect agents' views of economic uncertainty and prices.

Return Predictability, Variance Premium, Long Run Risks, Stochastic Volatility, Jump Risks

Abstract:
This paper examines the implications of payout horizon for the prices of aggregate cashflows. The interaction of two long-run forces - a long-run risk in consumption and aggregate dividends, and a cointegration relationship between consumption and aggregate dividends - leads to non-monotonic relationships between a payout's horizon and its cash flow risks, discount rate risks, and risk premia. These relationships with payout horizon are presented as term structures of risk sensitivities and return premia for so-called zero-coupon equity strips. Analytic expressions are derived for these term structures and examined to see how the interaction of long-run risk and cointegration determine risk and expected return. It is found that differences in payout horizon can result in significant differences in mean returns, with long-run strips earning the lowest risk premia and 'intermediate' term strips earning the highest premia. Based on this result, the paper then considers the possibility that differences in firms' payout horizon can account for a value premium within this long-run risks framework. Significant differences in mean returns can arise. However, when payout horizon is the sole difference between firms, the model is unable to account for the failure of the CAPM when calibrated to match first and second moments of aggregate consumption, dividends, and the market.

horizon, long run risk, duration, cointegration, value premium, zero coupon equity strips