Information-Driven Volatility

55 Pages Posted: 14 Nov 2021

See all articles by Hengjie Ai

Hengjie Ai

University of Minnesota - Carlson School of Management; affiliation not provided to SSRN

Leyla Jianyu Han

Boston University - Questrom School of Business

Lai Xu

Syracuse University

Date Written: November 10, 2021

Abstract

Modern asset pricing theory predicts an unambiguously positive relationship between volatility and expected returns. Empirically, however, realized volatility in the past often predicts expected returns in the future with a negative sign, as exemplified by the volatility-managed portfolios of Moreira and Muir (2017). Theoretically, we show that information-driven volatility induces a negative correlation between past realized volatility and expected volatility and expected returns in the future. We develop a simple asset pricing model based on this intuition and demonstrate that our model can account for several volatility-related asset pricing puzzles such as the return on volatility managed portfolios, the “variance risk premium” return predictability (Bollerslev, Tauchen, and Zhou, 2009), and the predictability of returns by implied volatility reduction on macroeconomic announcement days.

Keywords: Volatility Managed Portfolios, Variance Risk Premium, Macroeconomic Announcements, Generalized Risk Sensitivity

JEL Classification: D83, D84, G11, G12, G14

Suggested Citation

Ai, Hengjie and Han, Leyla Jianyu and Xu, Lai, Information-Driven Volatility (November 10, 2021). Available at SSRN: https://ssrn.com/abstract=3961096 or http://dx.doi.org/10.2139/ssrn.3961096

Hengjie Ai

University of Minnesota - Carlson School of Management ( email )

321 19th Avenue South
Minneapolis, MN 55455
United States

HOME PAGE: http://https://www.hengjieai.com/

affiliation not provided to SSRN

Leyla Jianyu Han (Contact Author)

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

HOME PAGE: http://www.leylahan.com/

Lai Xu

Syracuse University ( email )

900 S. Crouse Avenue
Syracuse, NY 13244-2130
United States

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