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Stock Return Predictability and Variance Risk Premia around the ZLB

Author

Listed:
  • Toshiaki Ogawa

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: toshiaki.ogawa@boj.or.jp))

  • Masato Ubukata

    (Professor, Faculty of Economics, Meiji Gakuin University (E-mail: ubukata@eco.meijigakuin.ac.jp))

  • Toshiaki Watanabe

    (Professor, Institute of Economic Research, Hitotsubashi University (E-mail: watanabe@ier.hit-u.ac.jp))

Abstract

We make an empirical analysis of whether and how variance risk premia (VRP) contribute to predicting excess stock returns in the US and Japan. Our new findings to be added to the literature are that (i) the correlation between VRP and future excess returns in the US is insignificant when the risk-free rate is close to zero, and (ii) the correlation in Japan is significantly negative. To explain these findings, we also conduct a preliminary theoretical analysis with a structural model of asset pricing based on two assumptions: the zero lower bound ( ZLB) for the risk-free rate, and a negative correlation between the consumption growth rate and the volatility-of-volatility. These allow excess returns to follow a hump-shaped pattern. This affects the sign and significance of the correlation of the returns with the VRP.

Suggested Citation

  • Toshiaki Ogawa & Masato Ubukata & Toshiaki Watanabe, 2020. "Stock Return Predictability and Variance Risk Premia around the ZLB," IMES Discussion Paper Series 20-E-09, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:20-e-09
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    References listed on IDEAS

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    More about this item

    Keywords

    Excess returns; Heterogeneous autoregressive model; Nikkei 225; Realized volatility; S&P500; Variance risk premium; Zero lower bound;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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