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Stock Returns and Volatility: Pricing the Short‐Run and Long‐Run Components of Market Risk
Author(s) -
ADRIAN TOBIAS,
ROSENBERG JOSHUA
Publication year - 2008
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2008.01419.x
Subject(s) - volatility (finance) , economics , volatility risk premium , volatility swap , implied volatility , forward volatility , volatility smile , econometrics , financial economics , short run , equity (law) , capital asset pricing model , monetary economics , political science , law
We explore the cross‐sectional pricing of volatility risk by decomposing equity market volatility into short‐ and long‐run components. Our finding that prices of risk are negative and significant for both volatility components implies that investors pay for insurance against increases in volatility, even if those increases have little persistence. The short‐run component captures market skewness risk, which we interpret as a measure of the tightness of financial constraints. The long‐run component relates to business cycle risk. Furthermore, a three‐factor pricing model with the market return and the two volatility components compares favorably to benchmark models.