The Variance Risk Premium in Equilibrium Models

61 Pages Posted: 3 Apr 2020 Last revised: 17 Mar 2022

See all articles by Geert Bekaert

Geert Bekaert

Columbia University - Columbia Business School, Finance

Eric Engstrom

Board of Governors of the Federal Reserve System

Andrey Ermolov

Fordham University - Gabelli School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 12, 2020

Abstract

The equity variance risk premium is the expected compensation earned for selling variance risk in equity markets. The variance risk premium is positive and shows only moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with risk neutral skewness being substantially more negative than physical return skewness, refute the bulk of the extant consumption-based asset pricing models. We introduce a tractable habit model that does fit the data. In the model, the variance risk premium depends positively (negatively) on "bad" ("good") consumption growth uncertainty.

Keywords: variance risk premium, risk-neutral skewness, non-Gaussian dynamics, bad volatility, VIX, habit

JEL Classification: E44, G12, G13

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Ermolov, Andrey, The Variance Risk Premium in Equilibrium Models (March 12, 2020). Available at SSRN: https://ssrn.com/abstract=3553547 or http://dx.doi.org/10.2139/ssrn.3553547

Geert Bekaert

Columbia University - Columbia Business School, Finance ( email )

NY
United States

Eric C. Engstrom

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-3044 (Phone)

Andrey Ermolov (Contact Author)

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States
9179690060 (Phone)

HOME PAGE: http://faculty.fordham.edu/aermolov1/

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