Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty

Abstract

This article reviews the predictability evidence on the variance risk premium: (a) It predicts significant positive risk premia across equity, bond, currency, and credit markets; (b) the predictability peaks at few-month horizons and dies out afterward; (c) such a short-run predictability is complementary to the long-run predictability offered by the price-to-earnings ratio, forward rate, interest differential, and leverage ratio. Several structural approaches based on the notion of economic uncertainty are discussed for generating these stylized facts about the variance risk premium, which has broad implications for various empirical asset pricing puzzles.