This paper formulates a new dynamic model for the variance risk premium based on a state space representation of a bivariate system for the observable ex-post realized variance and the ex-ante option implied variance expectation. A regime switching structure accommodates for periods of unusually high volatility, heterogeneous dynamics and changes in the dependence between the latent states. The model allows separating the continuous component of the variance risk premium from the impact of jumps on option implied variance expectations. Using options and high frequency returns for the S&P500 index, we explain what is generating return predictability by disentangling the part of the variance risk premium associated with normal sized price fluctuations from that associated with tail events. The latter component predicts to a significant extent, and asymmetrically with respect to their sign, future market return variations.