The Variance Risk Premium in Equilibrium Models

69 Pages Posted: 3 Apr 2020 Last revised: 4 May 2020

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

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 moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with a positive, yet moderate, difference between the risk-neutral entropy and variance of the aggregate market return, 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, macroeconomic uncertainty, non-Gaussian dynamics

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 Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
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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