Market Excess Returns, Variance and the Third Cumulant

40 Pages Posted: 13 Feb 2015

See all articles by Eric C. Chang

Eric C. Chang

University of Hong Kong - School of Business

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance

Huimin ZHAO

Sun Yat-Sen University (SYSU)

Date Written: February 12, 2015

Abstract

In this paper, we develop an equilibrium asset pricing model for the market excess return, variance and the third cumulant by using a jump-diffusion process with stochastic variance and jump intensity in Cox, Ingersoll and Ross' (1985) production economy. Empirical evidence with S&P 500 index and options from January 1996 to December 2005 strongly supports our model prediction that lower the third cumulant, higher the market excess returns. Consistent with existing literature, the theoretical mean-variance relation is supported only by regressions on risk-neutral variance. We further demonstrate empirically that the third cumulant explains significantly the variance risk premium.

Keywords: Equilibrium asset pricing model; Market excess return; Variance; The third cumulant; Variance risk premium

JEL Classification: G12, G13

Suggested Citation

Chang, Eric Chieh C. and Zhang, Jin E. and ZHAO, Huimin, Market Excess Returns, Variance and the Third Cumulant (February 12, 2015). Asian Finance Association (AsianFA) 2015 Conference Paper. Available at SSRN: https://ssrn.com/abstract=2564088 or http://dx.doi.org/10.2139/ssrn.2564088

Eric Chieh C. Chang

University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

Jin E. Zhang (Contact Author)

University of Otago, Otago Business School, Department of Accountancy and Finance ( email )

Dunedin, 9054
New Zealand
64 3 479 8575 (Phone)
64 3 479 8171 (Fax)

HOME PAGE: http://sites.google.com/site/jinzhanghomepage/home

Huimin ZHAO

Sun Yat-Sen University (SYSU) ( email )

135, Xingang Xi Road
Guangzhou, Guangdong 510275
China

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