Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty

This paper reviews the predictability evidence of the variance risk premium: (1) it predicts significant positive risk premiums across equity, bond, currency, and credit markets; (2) the predictability peaks at a few month horizons and dies out afterwards; (3) such a short-run predictability is complementary to the long-run predictability offered by P/E 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