Expected Stock Returns and Variance Risk Premia

Motivated by the implications from a stylized self-contained general equilibrium model incorporating the effects of time-varying economic uncertainty, we show that the difference between implied and realized variation, or the variance risk premium, is able to explain a nontrivial fraction of the time-series variation in post-1990 aggregate stock market returns, with high (low) premia predicting high (low) future returns. Our empirical results depend crucially on the use of "model-free, " as opposed to Black--Scholes, options implied volatilities, along with accurate realized variation measures constructed from high-frequency intraday as opposed to daily data. The magnitude of the predictability is particularly…