Forward Moments and Risk Premia Predictability

40 Pages Posted: 6 Mar 2017 Last revised: 31 Jan 2018

Panayiotis C. Andreou

Cyprus University of Technology

Anastasios Kagkadis

Lancaster University - Department of Accounting and Finance

Dennis Philip

Durham University Business School

Abderrahim Taamouti

Durham University

Date Written: January 30, 2018

Abstract

We estimate a term structure of risk-neutral forward skewness and examine its information content for equity market risk premia in conjunction with that of the already established forward variance. We use Partial Least Squares to extract from each term structure a single predictive factor that is motivated by the theoretical implications of affine no-arbitrage models. The resulting forward variance factor, FVF (forward skewness factor, FSF), reflects changes in the slope (curvature) of the term structure. The empirical analysis reveals that both factors exhibit significant in-sample and out-of sample predictability for the equity and the variance premium. More importantly, FSF exhibits equity premium predictability that is stronger than and incremental to that provided by FVF. However, FSF does not outperform FVF in the case of variance premium predictability.

Keywords: Forward Moments; Implied Volatility Surface; Partial Least Squares; Predictability of Stock Returns; Equity Premium; Variance Premium

JEL Classification: G10; G11; G12

Suggested Citation

Andreou, Panayiotis C. and Kagkadis, Anastasios and Philip, Dennis and Taamouti, Abderrahim, Forward Moments and Risk Premia Predictability (January 30, 2018). Available at SSRN: https://ssrn.com/abstract=2927454 or http://dx.doi.org/10.2139/ssrn.2927454

Panayiotis C. Andreou

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

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

Anastasios Kagkadis

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom

Dennis Philip (Contact Author)

Durham University Business School ( email )

Department of Economics and Finance
Mill Hill Lane
Durham, DH1 3LB
United Kingdom

Abderrahim Taamouti

Durham University ( email )

Old Elvet
Mill Hill Lane
Durham, Durham DH1 3HP
United Kingdom

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