Working Paper: NBER ID: w18411
Authors: John Y. Campbell; Stefano Giglio; Christopher Polk; Robert Turley
Abstract: This paper studies the pricing of volatility risk using the first-order conditions of a long-term equity investor who is content to hold the aggregate equity market rather than tilting towards value stocks and other equity portfolios that are attractive to short-term investors. We show that a conservative long-term investor will avoid such tilts in order to hedge against two types of deterioration in investment opportunities: declining expected stock returns, and increasing volatility. Empirically, we present novel evidence that low-frequency movements in equity volatility, tied to the default spread, are priced in the cross-section of stock returns.
Keywords: volatility risk; long-term investors; intertemporal asset pricing; equity returns; default spread
JEL Codes: G12; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conservative long-term investors (G23) | tilt towards value stocks (G11) |
| volatility (E32) | expected stock returns (G17) |
| growth stocks (G31) | hedge against declining expected returns (G17) |
| growth stocks (G31) | hedge against rising volatility (G13) |
| low-frequency movements in equity volatility (C58) | stock returns (G12) |
| default spread (D39) | expected stock returns (G17) |
| default spread (D39) | volatility (E32) |