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Characterizing the Variance Risk Premium: The Role of the Leverage Effect
[The term structure of variance swaps and risk premia]

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  • Guanglian Hu
  • Kris Jacobs
  • Sang Byung Seo

Abstract

The conditional covariance between the market return and its variance, which we refer to as the leverage effect, is positively related to the variance risk premium. It contains incremental information about the variance risk premium after controlling for other return moments and additional variables suggested by the literature as determinants of the variance risk premium. This empirical finding is supported by theory: the pricing of volatility risk is the economic channel behind the strong positive relation between the two variables. We use this relation to construct a time series of the variance risk premium dating back to 1926. (JEL G12, G13)Received February 7, 2020; editorial decision September 01, 2021.

Suggested Citation

  • Guanglian Hu & Kris Jacobs & Sang Byung Seo, 2022. "Characterizing the Variance Risk Premium: The Role of the Leverage Effect [The term structure of variance swaps and risk premia]," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 12(2), pages 500-542.
    • Handle: RePEc:oup:rasset:v:12:y:2022:i:2:p:500-542.
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    File URL: http://hdl.handle.net/10.1093/rapstu/raab027
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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