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Does variance risk premium predict expected returns?

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  • Xian-Ji Kuang
  • Yueh-Hua Hsu
  • Alan Chang
  • Shih-Kuei Lin

Abstract

The variance risk premium is a critical predictor of expected returns. However, numerous studies indicate that expected returns depend strongly on the state of the economy. Herein, we examine the effect of the variance risk premium in different market states by using cross – sectional regression and predictability of returns. Our empirical results show that the variance risk premium is a significantly priced factor in bull markets. Additionally, predicted return horizons are shorter in bear markets than in bull markets. Compared with that in bull markets, the predictive ability of the variance risk premium diminishes more rapidly in bear markets when the horizon period is lengthened.

Suggested Citation

  • Xian-Ji Kuang & Yueh-Hua Hsu & Alan Chang & Shih-Kuei Lin, 2024. "Does variance risk premium predict expected returns?," Applied Economics Letters, Taylor & Francis Journals, vol. 31(13), pages 1227-1233, July.
    • Handle: RePEc:taf:apeclt:v:31:y:2024:i:13:p:1227-1233
    DOI: 10.1080/13504851.2023.2178620
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