Title: Variance risk premium: Implications for financial and economic predictability
Authors: Helena Veiga - Universidad Carlos III de Madrid (Spain) [presenting]
Isabel Casas - University of Southern Denmark (Denmark)
Xiuping Mao - Universidad Carlos III (Spain)
Abstract: Using the decomposition of squared VIX into conditional variance of the stock market and equity variance risk premium, we explore the predictive power of both variables for stock returns, economic activity and financial instability. Measures of conditional variance and variance risk premium are obtained from new parametric and nonparametric asymmetric extensions of the heterogeneous autoregressive model (HAR). We find, using the new specifications, that the equity variance risk premium is a predictor of future stock returns while conditional variance is often rejected as a predictor for short and moderate prediction horizons. Furthermore, both variables are also predictors of financial instability and for some horizons of the economic activity. All in all, new nonparametric asymmetric measures of realized variance improve, considerably, the predictive power of the variance risk premium when considering stock market returns and financial instability.