| By: |
Tim Bollerslev (Duke University and CREATES);
Daniela Osterrieder (Aarhus University and CREATES);
Natalia Sizova (Rice University);
George Tauchen (Duke University and CREATES) |
| Abstract: |
The dynamic dependencies in financial market volatility are generally well
described by a long-memory fractionally integrated process. At the same time,
the volatility risk premium, defined as the difference between the ex-post
realized volatility and the market’s ex-ante expectation thereof, tends to be
much less persistent and well described by a short-memory process. Using newly
available intraday data for the S&P 500 and the VIX volatility index, coupled
with frequency domain inference procedures that allow us to focus on specific
parts of the spectra, we show that the existing empirical evidence based on
daily and coarser sampled data carries over to the high-frequency setting.
Guided by these empirical findings, we formulate and estimate a fractionally
cointegrated VAR model for the two high-frequency volatility series and the
corresponding high-frequency S&P 500 returns. Consistent with the implications
from a stylized equilibrium model that directly links the realized and
expected volatilities to returns, we show that the equilibrium variance risk
premium estimated with the intraday data within the fractionally cointegrated
system results in non-trivial return predictability over longer interdaily and
monthly horizons. These results in turn suggest that much of the existing
literature seeking to establish a risk-return tradeoff relationship between
expected returns and expected volatilities may be misguided, and that the
variance risk premium provides a much better proxy for the true economic
uncertainty that is being rewarded by the market. |
| Keywords: |
High-frequency data, realized volatility, options implied volatility, variance risk premium, fractional integration, long-memory, fractional cointegration, equilibrium asset pricing, return predictability. |
| JEL: |
C22 C32 C51 C52 G12 G13 G14 |
| Date: |
2011–12–21 |
| URL: |
http://d.repec.org/n?u=RePEc:aah:create:2011-51&r=mst |