Review of Finance Vol. 27 No. 6 2023

The Variance Risk Premium in Equilibrium Models

Geert Bekaert¹; Eric Engstrom²; Andrey Ermolov³

¹ Centre for Economic Policy Research, Columbia University , · ² Board of Governors of the Federal Reserve System , · ³ Gabelli School of Business, Fordham University ,

Abstract

The equity variance risk premium is the expected compensation earned for selling variance risk in equity markets. The variance risk premium is positive and shows only moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with risk-neutral skewness being substantially more negative than physical return skewness, refute the bulk of the extant consumption-based asset pricing models. We introduce a tractable habit model that does fit the data. In the model, the variance risk premium depends positively (or negatively) on “bad” (or “good”) consumption growth uncertainty.

DOI

10.1093/rof/rfad005

Volume

27

Issue

6

Pages

1977-2014

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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