Risk Premium, Variance Premium, and the Maturity Structure of Uncertainty

Abstract

Abstract Structural or no-arbitrage asset-pricing models emphasize risk factors that cannot be observed directly. We show that the term structure of risk implicit in option prices can reveal these risk factors. Empirically, the variance term structure reveals two predictors of the bond premium, the equity premium, and the variance premium, jointly. Similarly, the term structures of skewness and kurtosis measures also reveal risk factors, but these are subsumed in the predictive content of the variance. The predicted premium is countercyclical and robust to the inclusion of known returns predictors.