Variance Risk Premium Components and International Stock Return Predictability

64 Pages Posted: 20 Apr 2019 Last revised: 15 Aug 2019

See all articles by Juan M. Londono

Juan M. Londono

Federal Reserve Board of Governors

Nancy R. Xu

Boston College, Carroll School of Management

Date Written: August 14, 2019

Abstract

We document and explain the distinct dynamics and international predictability patterns of U.S. downside and upside variance risk premiums (DVP and UVP, respectively). We find that DVP, the compensation for bearing downside variance risk, is positive and countercyclical, whereas UVP is borderline positive with often negative spikes. Acknowledging for asymmetry in variance premium significantly improves its international stock return predictability. To rationalize our findings, we solve a dynamic asset pricing model featuring asymmetric non-Gaussian shocks and partial integration. We find that DVP is mostly driven by risk aversion, whereas UVP loads negatively on downside economic uncertainty. Moreover, DVP (UVP) transmits to international markets through financial (economic) integration.

Keywords: Downside variance risk premium, Upside variance risk premium, International stock markets, Asymmetric state variables, Stock return predictability

JEL Classification: F36, G12, G13, G15

Suggested Citation

Londono-Yarce, Juan-Miguel and Xu, Nancy R., Variance Risk Premium Components and International Stock Return Predictability (August 14, 2019). Available at SSRN: https://ssrn.com/abstract=3366592 or http://dx.doi.org/10.2139/ssrn.3366592

Juan-Miguel Londono-Yarce

Federal Reserve Board of Governors ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Nancy R. Xu (Contact Author)

Boston College, Carroll School of Management ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States

HOME PAGE: http://www.nancyxu.net

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