Downside Variance Risk Premium

FEDS Working Paper No. 2015-020

http://dx.doi.org/10.17016/FEDS.2015.020

66 Pages Posted: 26 Apr 2015

See all articles by Bruno Feunou

Bruno Feunou

Bank of Canada

Mohammad R. Jahan-Parvar

Board of Governors of the Federal Reserve System

Cedric Okou

University of Quebec at Montreal (UQAM)

Multiple version iconThere are 2 versions of this paper

Date Written: January 22, 2015

Abstract

We propose a new decomposition of the variance risk premium in terms of upside and downside variance risk premia. The difference between upside and downside variance risk premia is a measure of skewness risk premium. We establish that the downside variance risk premium is the main component of the variance risk premium, and that the skewness risk premium is a priced factor with significant prediction power for aggregate excess returns. Our empirical investigation highlights the positive and significant link between the downside variance risk premium and the equity premium, as well as a positive and significant relation between the skewness risk premium and the equity premium. Finally, we document the fact that the skewness risk premium fills the time gap between one quarter ahead predictability, delivered by the variance risk premium as a short term predictor of excess returns and traditional long term predictors such as price-dividend or price-earning ratios. Our resul ts are supported by a simple equilibrium consumption-based asset pricing model.

Keywords: Downside variance risk premium,Realized volatility,Risk-neutral volatility,Skewness risk premium,upside variance risk premium

JEL Classification: G12

Suggested Citation

Feunou, Bruno and Jahan-Parvar, Mohammad R. and Okou, Cedric, Downside Variance Risk Premium (January 22, 2015). http://dx.doi.org/10.17016/FEDS.2015.020. Available at SSRN: https://ssrn.com/abstract=2596796 or http://dx.doi.org/10.2139/ssrn.2596796

Bruno Feunou

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8302 (Phone)

HOME PAGE: http://kamkui.net/

Mohammad R. Jahan-Parvar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://sites.google.com/site/mrjahan/

Cedric Okou

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada
514-987-3000 Ext. 5521 (Phone)

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