A0742
Title: Stock return predictability of the market variance risk premium in Japan
Authors: Toshiaki Watanabe - Hitotsubashi University (Japan) [presenting]
Masato Ubukata - Kushiro Public University of Economics (Japan)
Abstract: The variance risk premium (VRP) is defined as the difference between the forecast of return variance (volatility) under the risk neutral measure and that under the physical measure. Recent empirical evidence suggests that the VRPs of stock indexes predict the excess return of those indexes but it is not true for the Nikkei 225 stock index in Japan. The stock return predictability of the VRP of the Nikkei 225 index is re-examined by predicting the volatility under the physical measure based on the monthly data on the index of industrial production (IIP) in Japan as well as the daily return of the Nikkei 225 index while only financial data is used in the previous literature. The monthly and daily data are combined by employing the GARCH-MIDAS model where the daily volatility is divided into the monthly component that depends on the past monthly data on the IIP and the daily component that follows a GARCH model. It is demonstrated that the new variance risk premium of the Nikkei 225 index predicts the excess return. It is also found that the movement of stock market volatility is counter-cyclical in Japan.
