Abstract
Stock market volatility clusters in time, appears fractionally integrated, carries a risk premium, and exhibits asymmetric leverage effects. At the same time, the volatility risk premium, defined by the difference between the risk-neutral and objective expectations of the volatility, features short memory. This paper develops the first internally consistent equilib- rium-based explanation for all these empirical facts. Using newly available high-frequency intra- day data for the S&P 500 and the VIX volatility index, the authors show that the qualitative implications from the new theoretical continuous-time model match remarkably well with the dis- tinct shapes and patterns in the sample autocorrelations and dynamic cross-correlations actually observed in the data.
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