Volatility Expectations and Returns
We provide evidence that agents have slow-moving beliefs about stock market volatility that lead to initial underreaction to volatility shocks followed by delayed overreaction. These dynamics are mirrored in the VIX and variance risk premiums which reflect investor expectations about volatility and are also supported in surveys and in firm-level option prices. We embed these expectations into an asset pricing model and find that the model can account for a number of stylized facts about market returns and return volatility which are difficult to reconcile, including a weak, or even negative, risk-return tradeoff.
We thank seminar participants at NBER Behavioral Finance, Virtual Finance Seminar, UCLA, UT Austin, Tilburg, Toronto, Insead, Norwegian School of Economics, Maastricht, Nova, and Amsterdam, and Andy Atkeson, Nick Barberis, John Campbell, Ing-Haw Cheng, Mike Chernov, Itamar Dreschler (discussant), Andrea Eisfeldt, Stefano Giglio (discussant), Valentin Haddad, Barney Hartman-Glaser, Hanno Lustig, Alan Moreira, Stefan Nagel, Stavros Panageas, Andrei Shleifer, Kelly Shue, and two anonymous referees for comments. We thank James O’Neill and Alvaro Boitier for excellent research assistance. We thank Ing-Haw Cheng, Stefano Giglio, Ian Dew-Becker, and Travis Johnson for making data available. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
LARS A. LOCHSTOER & TYLER MUIR, 2022. "Volatility Expectations and Returns," The Journal of Finance, vol 77(2), pages 1055-1096.