Working Paper: NBER ID: w18995
Authors: Geert Bekaert; Marie Hoerova
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. The latter is increasing in risk aversion in a wide variety of economic settings. We tackle several measurement issues assessing a plethora of state-of-the-art volatility forecasting models. We then examine the predictive power of the VIX and its two components for stock market returns and economic activity. The variance premium predicts stock returns but the conditional stock market variance predicts economic activity, and is more contemporaneously correlated with financial instability than is the variance premium.
Keywords: VIX; variance premium; stock market volatility; risk aversion; economic activity
JEL Codes: C22; C52; E32; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Conditional Variance (CV) (C29) | Stock Returns (G12) |
| Variance Premium (VP) (C29) | Economic Activity (R11) |
| Variance Premium (VP) (C29) | Stock Returns (G12) |
| Conditional Variance (CV) (C29) | Economic Activity (R11) |
| Variance Premium (VP) (C29) | Risk Aversion (D81) |