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The VIX, the variance premium and stock market volatility

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  • Hoerova, Marie
  • Bekaert, Geert

Abstract

We decompose the squared VIX index, derived from US S&P500; options prices, into the conditional variance of stock returns and the equity variance premium. We evaluate a plethora of state-of-the-art volatility forecasting models to produce an accurate measure of the conditional variance. We then examine the predictive power of the VIX and its two components for stock market returns, economic activity and financial instability. The variance premium predicts stock returns while the conditional stock market variance predicts economic activity and has a relatively higher predictive power for financial instability than does the variance premium. JEL Classification: C22, C52, G12, E32

Suggested Citation

  • Hoerova, Marie & Bekaert, Geert, 2014. "The VIX, the variance premium and stock market volatility," Working Paper Series 1675, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20141675
    Note: 919428
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    More about this item

    Keywords

    economic uncertainty; financial instability; option implied volatility; realized volatility; risk-return trade-off; risk aversion; stock return predictability; variance risk premium; VIX;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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