Working Paper: NBER ID: w28102
Authors: Lars A. Lochstoer; Tyler Muir
Abstract: We provide evidence that agents have slow-moving beliefs about stock market volatility that lead to initial underreaction to volatility shocks followed by delayed overreaction. These dynamics are mirrored in the VIX and variance risk premiums which reflect investor expectations about volatility and are also supported in surveys and in firm-level option prices. We embed these expectations into an asset pricing model and find that the model can account for a number of stylized facts about market returns and return volatility which are difficult to reconcile, including a weak, or even negative, risk-return tradeoff.
Keywords: No keywords provided
JEL Codes: G00; G12; G4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased volatility (E32) | lower variance risk premium (D81) |
| lower variance risk premium (D81) | stock prices decline (G10) |
| delayed overreaction (G41) | further decline in stock prices (G10) |
| agents' beliefs about volatility (D84) | stock prices (G12) |
| volatility shocks (E32) | agents' beliefs about volatility (D84) |
| realized returns (G19) | volatility innovations (C58) |
| variance risk premium (D81) | stock returns (G12) |