The Pricing of Long and Short Run Variance and Correlation Risk in Stock Returns

Posted: 4 May 2011 Last revised: 26 Feb 2017

See all articles by Mathijs Cosemans

Mathijs Cosemans

Erasmus University - Rotterdam School of Management

Date Written: April 29, 2011

Abstract

This paper studies the pricing of long and short run variance and correlation risk. The predictive power of the market variance risk premium for returns is driven by the correlation risk premium and the systematic part of individual variance premia. Furthermore, I find that aggregate volatility risk is priced in the cross-section because shocks to average stock volatility and correlation are priced. Both long and short run volatility and correlation factors have explanatory power for returns. Finally, I resolve the idiosyncratic volatility puzzle by showing that short-term idiosyncratic risk is positively priced whereas long-term idiosyncratic volatility carries a negative price.

Keywords: variance risk, correlation risk, idiosyncratic risk, return predictability

JEL Classification: G12, G14

Suggested Citation

Cosemans, Mathijs, The Pricing of Long and Short Run Variance and Correlation Risk in Stock Returns (April 29, 2011). Available at SSRN: https://ssrn.com/abstract=1825934 or http://dx.doi.org/10.2139/ssrn.1825934

Mathijs Cosemans (Contact Author)

Erasmus University - Rotterdam School of Management ( email )

Burgemeester Oudlaan 50
Rotterdam
Netherlands
+31104082371 (Phone)
+31104089017 (Fax)

HOME PAGE: http://www.mathijscosemans.com

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