Abstract
We find that the market variance risk premium (VRP) beta (exposure to the market variance risk), size, and idiosyncratic volatility jointly explain the cross-sectional VRPs. We construct novel VRP common factors related to these three characteristics. In regressions of the VRPs of 25 size and book-to-market sorted portfolios, our factors explain the VRPs with adjusted R-squares ranging from 57% to 88%, compared to the Carhart (1997) four factors with adjusted R-squares of 5% to 24%. Our factors and the Carhart factors are not interchangeable.
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