Abstract

https://ssrn.com/abstract=2747169
 


 



VIX Decomposition, the Price of Fear and Stock Return Predictability


Victor Chow


West Virginia University

Wanjun Jiang


Guang Hua School of Management, Peking University

Jingrui Li


West Virginia University

December 30, 2016


Abstract:     
The VIX is not just a volatility index but a fear gauge. We formalize this market perception with a linear decomposition of the VIX that consists with four fundamentally different elements: the realized variance (RV), the variance risk premium (VRP), the realized tail (RT), and the tail risk premium (TRP), respectively. The VRP compensates the anticipated (normal) market volatility, and the TRP prices the fear of potentially (unusual) large market movements. Empirically, approximate one-third of the VIX's formation is attributed to the TRP. In addition to VRP, RT and TRP are crucial components for predicting future returns on equity portfolios.

Number of Pages in PDF File: 53

Keywords: Variance Risk Premium, Tail Risk Premium, Quadratic Variation, Polynomial Variation, Realized Variance, Realized Tail.

JEL Classification: C22, C51, C52, G1, G12, G13


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Date posted: March 14, 2016 ; Last revised: January 6, 2017

Suggested Citation

Chow, Victor and Jiang, Wanjun and Li, Jingrui, VIX Decomposition, the Price of Fear and Stock Return Predictability (December 30, 2016). Available at SSRN: https://ssrn.com/abstract=2747169

Contact Information

Victor Chow (Contact Author)
West Virginia University ( email )
P. O. Box 6025
Morgantown, WV 26506
United States
Wanjun Jiang
Guang Hua School of Management, Peking University ( email )
Beijing
China
Jingrui Li
West Virginia University ( email )
PO Box 6025
Morgantown, WV 26506
United States
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