The Variance Risk Premium in Equilibrium Models
69 Pages Posted: 3 Apr 2020 Last revised: 4 May 2020
Date Written: March 12, 2020
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: Suggested Citation