The VIX, the Variance Premium, and Expected Returns

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DOI

  • Daniela Osterrieder
  • Daniel Ventosa-Santaulària, Centro de Investigación y Docencia Económicas (CIDE
  • ,
  • J. Eduardo Vera-Valdés, Aalborg University

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.

Original languageEnglish
JournalJournal of Financial Econometrics
Volume17
Issue4
Pages (from-to)517-558
Number of pages42
ISSN1479-8409
DOIs
Publication statusPublished - 2019

    Research areas

  • fractional integration, implied variance, integrated variance, persistent predictor, return prediction, risk-return trade-off, variance premium

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