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Stock returns and volatility: pricing the short-run and long-run components of market risk

  • Tobias Adrian
  • Joshua Rosenberg

We decompose the time series of equity market risk into short- and long-run volatility components. Both components have negative and highly significant prices of risk in the cross section of equity returns. A three-factor model with the market return and the two volatility components compares favorably to benchmark models. We show that the short-run component captures market skewness risk, while the long-run component captures business cycle risk. Furthermore, short-run volatility is the more important cross-sectional risk factor, even though its average risk premium is smaller than the premium of the long-run component.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 254.

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Date of creation: 2006
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Handle: RePEc:fip:fednsr:254
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