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Expected Stock Returns and Variance Risk Premia

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

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

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).

Number of Pages in PDF File: 41

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

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Date posted: September 21, 2006 ; Last revised: December 14, 2008

Suggested Citation

Bollerslev, Tim and Tauchen, George 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: http://ssrn.com/abstract=948309 or http://dx.doi.org/10.2139/ssrn.948309

Contact Information

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 ( email )
43 Chengfu Road, Haidian District
Beijing, 100083
+86-10-62790655 (Phone)
HOME PAGE: http://www.pbcsf.tsinghua.edu.cn
Feedback to SSRN

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