Abstract
We use equity option prices and high frequency stock prices to estimate stock’s variance risk premium (V RP ), dened as the dierence between the expected variances under the risk-neutral measure and under the empirical measure. Cross-sectionally, V RP is signicantly related to stocks’ sensitivities to common risk factors. In particular, stocks whose returns tend to be low when systematic volatility increases have higher variance risk premium. We nd that stock’s expected returns increase with their variance risk premium. Stocks ranked in the top V RP quintile on average outperform those in the bottom quintile by 1.84% (resp. 1.44%) per month when portfolios are value-weighted (resp. equal-weighted). We reject explanations based on stock mispricing or informed trading in options. Our result is linked to another new nding: stocks with low beta with respect to change in the average idiosyncratic volatility or the market variance risk premium have high expected returns.
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