TY - JOUR
T1 - The VIX, the Variance Premium, and Expected Returns
AU - Osterrieder, Daniela
AU - Ventosa-Santaulària, Daniel
AU - Vera-Valdés, J Eduardo
PY - 2019
Y1 - 2019
N2 - Existing studies find conflicting estimates of the risk–return relation. We show that the trade-off parameter is inconsistently estimated when observed or estimated conditional variances measure risk. The inconsistency arises from misspecified, unbalanced, and endogenous return regressions. These problems are eliminated if risk is captured by the variance premium (VP) instead; it is unobservable, however. We propose a 2SLS estimator that produces consistent estimates without observing the VP. Using this method, we find a positive risk–return trade-off and long-run return predictability. Our approach outperforms commonly used risk–return estimation methods, and reveals a significant link between the VP and economic uncertainty.
AB - Existing studies find conflicting estimates of the risk–return relation. We show that the trade-off parameter is inconsistently estimated when observed or estimated conditional variances measure risk. The inconsistency arises from misspecified, unbalanced, and endogenous return regressions. These problems are eliminated if risk is captured by the variance premium (VP) instead; it is unobservable, however. We propose a 2SLS estimator that produces consistent estimates without observing the VP. Using this method, we find a positive risk–return trade-off and long-run return predictability. Our approach outperforms commonly used risk–return estimation methods, and reveals a significant link between the VP and economic uncertainty.
KW - fractional integration
KW - implied variance
KW - integrated variance
KW - persistent predictor
KW - return prediction
KW - risk-return trade-off
KW - variance premium
U2 - 10.1093/jjfinec/nby008
DO - 10.1093/jjfinec/nby008
M3 - Journal article
SN - 1479-8409
VL - 17
SP - 517
EP - 558
JO - Journal of Financial Econometrics
JF - Journal of Financial Econometrics
IS - 4
ER -