Good and Bad Variance Premia and Expected Returns

52 Pages Posted: 25 Aug 2017

See all articles by Mete Kilic

Mete Kilic

University of Southern California - Marshall School of Business

Ivan Shaliastovich

University of Wisconsin - Madison

Date Written: July 5, 2017

Abstract

We measure "good" and "bad" variance premia that capture risk compensations for the realized variation in positive and negative market returns, respectively. The two variance premium components jointly predict excess returns over the next 1 and 2 years with statistically significant positive (negative) coefficients on the good (bad) component. The R2s reach about 10% for aggregate equity and portfolio returns, and 20% for corporate bond returns. To explain the new empirical evidence, we develop a model that highlights the differential impact of upside and downside risk on equity and variance risk premia.

Keywords: Variance premium, return predictability, upside and downside risk

Suggested Citation

Kilic, Mete and Shaliastovich, Ivan, Good and Bad Variance Premia and Expected Returns (July 5, 2017). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3024086 or http://dx.doi.org/10.2139/ssrn.3024086

Mete Kilic (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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