Variance Risk Premium Components and International Stock Return Predictability
60 Pages Posted: 20 Apr 2019 Last revised: 23 Mar 2020
Date Written: March 19, 2020
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
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