Title: Term structure of variance risk premium and returns' predictability
Authors: Giacomo Bormetti - University of Bologna (Italy) [presenting]
Fulvio Corsi - University of Pisa and City University London (Italy)
Adam Aleksander Majewski - QUANT Lab Pisa (Italy)
Abstract: An analytic relation between equity risk premium and the term structure of variance risk premium (VRP) is derived. Motivated by this result, we estimate the VRP term structure using a general and fully analytical discrete-time option pricing framework featuring multiple volatility components and multiple risk premia. We confirm the importance of VRP in improving option pricing performances and show the ability of multi-component GARCH models to produce realistic hump-shaped VRP term structure. We finally uncover the strong predictive power of the shape of the VRP term structure on future stock-index returns.