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This paper studies the pricing of long and short run variance and correlation risk. The predictive power of the market variance risk premium for returns is driven by the correlation risk premium and the systematic part of individual variance premia. Furthermore, I find that aggregate volatility risk is priced in the cross-section because shocks to average stock volatility and correlation are priced. Both long and short run volatility and correlation factors have explanatory power for returns. Finally, I resolve the idiosyncratic volatility puzzle by showing that short-term idiosyncratic risk is positively priced whereas long-term idiosyncratic volatility carries a negative price.

The Pricing of Long and Short Run Variance and Correlation Risk in Stock Returns