Variance Risk Premium Components and International Stock Return Predictability

60 Pages Posted: 20 Apr 2019 Last revised: 23 Mar 2020

See all articles by Juan M. Londono

Juan M. Londono

Board of Governors of the Federal Reserve System

Nancy R. Xu

Boston College, Carroll School of Management

Date Written: March 19, 2020

Abstract

We decompose the U.S. variance risk premium (VP) into its downside and upside components (DVP and UVP, respectively) as proxies for asymmetric global risk variables, and find that acknowledging for asymmetry in VP significantly improves its international stock return predictability. To rationalize our empirical findings, we propose an international dynamic asset pricing model featuring asymmetric non-Gaussian shocks and partial global integration. We find that (i) DVP (UVP) is mostly driven by global risk aversion (economic uncertainty), (ii) international equity risk premiums exhibit distinct loadings on global premium determinants, and (iii) 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 (March 19, 2020). Available at SSRN: https://ssrn.com/abstract=3366592 or http://dx.doi.org/10.2139/ssrn.3366592

Juan-Miguel Londono-Yarce

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
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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