Term Structure of Variance Risk Premium and Returns' Predictability

Download or read book Term Structure of Variance Risk Premium and Returns' Predictability written by Giacomo Bormetti and published by . This book was released on 2016 with total page 49 pages. Available in PDF, EPUB and Kindle. Book excerpt: We derive an analytic relation between equity risk premium and the term structure of variance risk premium (VRP). 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, summarized by its slope, on future stock-index returns.