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Tail risk premia and return predictability

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  • Bollerslev, Tim
  • Todorov, Viktor
  • Xu, Lai

Abstract

The variance risk premium, defined as the difference between the actual and risk-neutral expectations of the forward aggregate market variation, helps predict future market returns. Relying on a new essentially model-free estimation procedure, we show that much of this predictability may be attributed to time variation in the part of the variance risk premium associated with the special compensation demanded by investors for bearing jump tail risk, consistent with the idea that market fears play an important role in understanding the return predictability.

Suggested Citation

  • Bollerslev, Tim & Todorov, Viktor & Xu, Lai, 2015. "Tail risk premia and return predictability," Journal of Financial Economics, Elsevier, vol. 118(1), pages 113-134.
  • Handle: RePEc:eee:jfinec:v:118:y:2015:i:1:p:113-134
    DOI: 10.1016/j.jfineco.2015.02.010
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    Cited by:

    1. Faria, Gonçalo & Verona, Fabio, 2018. "Forecasting stock market returns by summing the frequency-decomposed parts," Journal of Empirical Finance, Elsevier, vol. 45(C), pages 228-242.
    2. Nguyen, Duc Binh Benno & Prokopczuk, Marcel & Wese Simen, Chardin, 2017. "The Risk Premium of Gold," Hannover Economic Papers (HEP) dp-616, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    3. Torben G. Andersen & Nicola Fusari & Viktor Todorov, 2017. "Short-Term Market Risks Implied by Weekly Options," Journal of Finance, American Finance Association, vol. 72(3), pages 1335-1386, June.
    4. William N. Goetzmann & Dasol Kim & Robert J. Shiller, 2016. "Crash Beliefs From Investor Surveys," NBER Working Papers 22143, National Bureau of Economic Research, Inc.
    5. repec:eee:eneeco:v:67:y:2017:i:c:p:410-422 is not listed on IDEAS
    6. Feunou, Bruno & Jahan-Parvar, Mohammad & Okou, Cedric, 2015. "Downside Variance Risk Premium," Finance and Economics Discussion Series 2015-20, Board of Governors of the Federal Reserve System (U.S.).
    7. Nguyen, Duc Binh Benno & Prokopczuk, Marcel & Wese Simen, Chardin, 2017. "International Tail Risk and World Fear," Hannover Economic Papers (HEP) dp-620, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
    8. Torben G. Andersen & Nicola Fusari & Viktor Todorov, 1001. "The Pricing of Tail Risk and the Equity Premium: Evidence from International Option Markets," CREATES Research Papers 2018-02, Department of Economics and Business Economics, Aarhus University.
    9. Escribano Sáez, Álvaro & Blazsek, Szabolcs Istvan & Ayala, Astrid, 2017. "Dynamic conditional score models with time-varying location, scale and shape parameters," UC3M Working papers. Economics 25043, Universidad Carlos III de Madrid. Departamento de Economía.
    10. Caio Almeida & Kym Ardison & René Garcia & Jose Vicente, 2017. "Nonparametric Tail Risk, Stock Returns, and the Macroeconomy," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 15(3), pages 333-376.
    11. Pelster, Matthias & Vilsmeier, Johannes, 2016. "The determinants of CDS spreads: Evidence from the model space," Discussion Papers 43/2016, Deutsche Bundesbank.
    12. Torben G. Andersen & Nicola Fusari & Viktor Todorov, 2015. "The Pricing of Short-Term market Risk: Evidence from Weekly Options," NBER Working Papers 21491, National Bureau of Economic Research, Inc.

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