Reexamining Financial and Economic Predictability with New Estimators of Realized Variance and Variance Risk Premium

CREATES Research Paper 2018-10

Posted: 5 Mar 2018 Last revised: 9 Mar 2018

Isabel Casas

University of Southern Denmark

Xiuping Mao

Zhongnan University of Economics and Law - School of Finance

Helena Veiga

Universidad Carlos III de Madrid - Department of Statistics and Econometrics

Date Written: February 21, 2018

Abstract

This study explores the predictive power of new estimators of the equity variance risk premium and conditional variance for future excess stock market returns, economic activity, and financial instability, both during and after the last global financial crisis. These estimators are obtained from new parametric and semiparametric asymmetric extensions of the heterogeneous autoregressive model. Using these new specifications, we determine that the equity variance risk premium is a predictor of future excess stock returns, whereas conditional variance predicts them only for long horizons. Moreover, a comparison of the overall results reveals that the conditional variance gains predictive power during the global financial crisis period. Furthermore, both the variance risk premium and conditional variance are determined to be predictors of future financial instability, whereas conditional variance is determined to be the only predictor of economic activity for all horizons. Before the global financial crisis period, the new parametric asymmetric specification of the heterogeneous autoregressive model gains predictive power in comparison to previous work in the literature. However, the new time-varying coefficient models are the ones showing considerably higher predictive power for stock market returns and financial instability during the financial crisis, suggesting that an extreme volatility period requires models that can adapt quickly to turmoil.

Keywords: Net Measures, Nonparametric Methods, Predictability, Realized Variance, Variance Risk Premium, VIX

JEL Classification: C22, C51, C52, C53, C58, G17

Suggested Citation

Casas, Isabel and Mao, Xiuping and Veiga, Helena, Reexamining Financial and Economic Predictability with New Estimators of Realized Variance and Variance Risk Premium (February 21, 2018). CREATES Research Paper 2018-10. Available at SSRN: https://ssrn.com/abstract=3134390

Isabel Casas (Contact Author)

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

Xiuping Mao

Zhongnan University of Economics and Law - School of Finance ( email )

WenQuan Building, 182# Nanhu Avenue
East Lake High-tech Development Zone
Wuhan, Hubei 430073
China

Helena Veiga

Universidad Carlos III de Madrid - Department of Statistics and Econometrics ( email )

c/ Madrid 126
Getafe (Madrid), 28903
Spain

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