Abstract
This article examines the properties of the variance risk premium (VRP). We propose a flexible asset pricing model that captures co-jumps in prices and volatility, and self-exciting jump clustering. We estimate the model on equity returns and variance swap rates at different horizons. The total VRP is negative and has a downward-sloping term structure, while its jump component displays an upward-sloping term structure. The abrupt and persistent response of the short-term jump VRP to extreme events makes this specific premium a proxy for investors’ fear of a market crash. Furthermore, the use of the VRP level and slope, and of its components, helps improve the short-run predictability of equity excess returns.
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