۱- Introduction

۲- Data and methodology

۳- Empirical analysis

۴- Robustness check

۵- Concluding remarks

References

Abstract 

This paper investigates return and cash flow predictability via the decomposition of VIX. The squared VIX index is decomposed into expected return variations (ERV) and variance risk premium (VRP). Without imposing a strong assumption on the dynamics of the return variations, I examine the predictability via the generalized method of moments (GMM) approach with appropriately chosen instruments. Empirical analysis shows the short-term return predictability of VRP and the short- and long-term cash flow predictability of ERV.

Concluding remarks

This paper shows the short-term return predictability of VRP and the short- and long-term cash flow predictability of ERV. As argued by Bekaert and Hoerova (2014), the return predictability of VRP can potentially be explained in terms of the ‘‘habit’’ advocated by Campbell and Cochrane (1999). Their habit-induced counter-cyclical changes in risk aversion generate variations in risk premiums. On the other hand, one candidate theory for the cash flow predictability of ERV may be the long-run risk model (e.g., Bansal and Yaron, 2004). Economic uncertainty, which can be proxied by ERV, is a key variable in the long-run risk model. In a version of the model in Bollerslev et al. (2015), innovations in time-varying volatility and the long-run risk factor are correlated; thus, the long-run risk factor can have a persistent effect on dividend growth. This specification may drive the long-term cash flow predictability of ERV. It would be interesting to develop a version of the long-run risk model that leads to long-run cash flow predictability of economic uncertainty in future research.