Characterizing the Variance Risk Premium: The Role of the Leverage Effect
58 Pages Posted: 27 Aug 2018 Last revised: 7 Aug 2019
Date Written: July 18, 2019
A substantial portion of the variation in the market variance risk premium can be explained by the conditional covariance between the market return and its variance, which we refer to as the leverage effect. This finding holds at different data frequencies and for various sample periods, and it is robust to controlling for other variables used to characterize the variance risk premium. We consider dynamic equilibrium models in which the variance risk premium and the leverage effect arise endogenously, and show that the pricing of volatility risk is the economic channel behind the strong positive relation between the two variables.
JEL Classification: G12 G13
Suggested Citation: Suggested Citation