A0477
Title: Correlation risk premium and return predictability
Authors: Xingzhi Yao - Xi\'an Jiaotong Liverpool University (China) [presenting]
Zhenxiong Li - Soochow University (China)
Abstract: The correlation risk premium, defined as the difference between the implied and realized correlation, is shown to be a robust predictor of long-term market returns. The presence of significant premium is documented across nine industrial sectors in the US market, indicating that investors are concerned about the high correlation and are willing to pay a premium in order to hedge market situations with sharp increases in correlation. In addition, it is shown that the industrial implied correlations are fractionally cointegrated, and the long-run component extracted by the co-fractional system carries a nontrivial degree of market return predictability. The empirical findings are supported by the simulation evidence.
