Conditional equity risk premia and realized variance jump risk

This study explores the relationship between realized variance jump risk and conditional equity risk premium. Using high frequency records of the Standard & Poor’s 500 index, we construct a realized variance measure and estimate its jump component using a Heterogeneous Autoregressive model augmented by a jump component. We find strong evidence that the realized variance jump risk measure significantly relates to excess stock market returns in-sample and out-of-sample from 1998 to 2010. Further, the predictive power of the variance jump remains both statistically and economically significant after controlling for commonly-used return predictors, and is also independent from variance risk premium and price jump risk. Calibration-based evidence is also consistent with our empirical findings.