Working Paper: NBER ID: w27108
Authors: Geert Bekaert; Eric Engstrom; Andrey Ermolov
Abstract: The equity variance risk premium is the expected compensation earned for selling variance risk in equity markets. The variance risk premium is positive and shows moderate persistence. High variance risk premiums coincide with the left tail of the consumption growth distribution shifting down. These facts, together with a positive, yet moderate, difference between the risk-neutral entropy and variance of the aggregate market return, refute the bulk of the extant consumption-based asset pricing models. We introduce a tractable habit model that does fit the data. In the model, the variance risk premium depends positively (negatively) on “bad” (“good”) consumption growth uncertainty.
Keywords: variance risk premium; consumption-based asset pricing; equity markets
JEL Codes: E44; G12; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| variance risk premium (D81) | bad consumption growth uncertainty (F62) |
| variance risk premium (D81) | good consumption growth uncertainty (F62) |
| variance risk premium (D81) | consumption growth distribution (F62) |
| bad consumption growth volatility (F62) | variance risk premium (D81) |
| variance risk premium (D81) | left tail of consumption growth distribution (F62) |