The Variance Risk Premium and Fundamental Uncertainty
Economics Letters, Forthcoming
11 Pages Posted: 3 Mar 2015 Last revised: 15 Jul 2015
Date Written: April 1, 2015
Abstract
We propose a new measure of the expected variance risk premium that is based on a forecast of the conditional variance from a GARCH-MIDAS model. We find that the new measure has strong predictive ability for future U.S. aggregate stock market returns and rationalize this result by showing that the new measure effectively isolates fundamental uncertainty as the factor that drives the variance risk premium.
Keywords: Variance risk premium, return predictability, VIX, GARCH-MIDAS, economic uncertainty, vol-of-vol
JEL Classification: C53, C58, E32, G12, G17
Suggested Citation: Suggested Citation