Characterizing the Variance Risk Premium: The Role of the Leverage Effect

58 Pages Posted: 27 Aug 2018 Last revised: 7 Aug 2019

See all articles by Guanglian Hu

Guanglian Hu

The University of Sydney - Discipline of Finance

Kris Jacobs

University of Houston - C.T. Bauer College of Business

Sang Byung Seo

University of Wisconsin - Madison

Date Written: July 18, 2019

Abstract

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

Hu, Guanglian and Jacobs, Kris and Seo, Sang Byung, Characterizing the Variance Risk Premium: The Role of the Leverage Effect (July 18, 2019). Finance Down Under 2019 Building on the Best from the Cellars of Finance, Available at SSRN: https://ssrn.com/abstract=3227211 or http://dx.doi.org/10.2139/ssrn.3227211

Guanglian Hu (Contact Author)

The University of Sydney - Discipline of Finance ( email )

Room 543 H69 Codrington Building
University of Sydney
Sydney, NSW 2006
Australia

Kris Jacobs

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Sang Byung Seo

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706-1324

HOME PAGE: http://sites.google.com/site/sangbyungseo

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