Recent empirical evidence suggests that the variance risk premium,
or the difference between risk-neutral and statistical expectations
of the future return variation, predicts aggregate stock market
returns, with the predictability especially strong at the 2-4 month
horizons. We provide extensive Monte Carlo simulation evidence that
statistical finite sample biases in the overlapping return
regressions underlying these findings can not explain" this
apparent predictability. Further corroborating the existing
empirical evidence, we show that the patterns in the predictability
across different return horizons estimated from country specific
regressions for France, Germany, Japan, Switzerland and the U.K.
are remarkably similar to the pattern previously documented for the
U.S. Defining a global" variance risk premium, we uncover even
stronger predictability and almost identical cross-country patterns
through the use of panel regressions that effectively restrict the
compensation for world-wide variance risk to be the same across
countries. Our findings are broadly consistent with the
implications from a stylized two-country general equilibrium model
explicitly incorporating the effects of world-wide time-varying
economic uncertainty.
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