Department of Economics and Business Economics

Dynamics of Variance Risk Premia, Investors' Sentiment and Return Predictability

Publication: ResearchWorking paper

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  • rp17_10

    Final published version, 925 KB, PDF-document

  • Jerome V.K. Rombouts
    Jerome V.K. RomboutsESSEC Business SchoolFrance
  • Lars Stentoft
    Lars StentoftDepartment of Economics and Department of Statistical and Actuarial Sciences, University of Western Ontario
  • Francesco Violante
We develop a joint framework linking the physical variance and its risk neutral expectation implying variance risk premia that are persistent, appropriately reacting to changes in level and variability of the variance and naturally satisfying the sign constraint. Using option market data and realized variances, our model allows to infer the occurrence and size of extreme variance events, and construct indicators signalling agents sentiment towards future market conditions. Our results show that excess returns are to a large extent explained by fear or optimism towards future extreme variance events and only marginally by the premium associated with normal price fluctuations.
Original languageEnglish
Place of PublicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages72
StatePublished - 7 Mar 2017
SeriesCREATES Research Papers
Number2017-10

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