Predictability Puzzles

51 Pages Posted: 8 Jul 2020

See all articles by Bjorn Eraker

Bjorn Eraker

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Date Written: June 12, 2020

Abstract

Dynamic equilibrium models based on present value computation imply that returns are predictable but also generate particular patterns of predictability in asset returns. I take advantage of this to construct a set of tests of Equilibrium Generated Predictability (EGP). I apply the tests to document two puzzles: First, option implied or realized measures of volatility ought to predict returns but do not. Second, the Variance Risk Premium (VRP) predicts returns but only at long horizons. VRP fails the tests of EGP as the term structure of predictable variation is inconsistent with an equilibrium interpretation.

Keywords: Predictability, VRP, Equilibrium, Expected Returns

JEL Classification: G1, G17, G11, G13, G12

Suggested Citation

Eraker, Bjorn, Predictability Puzzles (June 12, 2020). Available at SSRN: https://ssrn.com/abstract=3625709 or http://dx.doi.org/10.2139/ssrn.3625709

Bjorn Eraker (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States

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