Stock Returns and Volatility: Pricing the Short-Run and Long-Run Components of Market Risk




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    • Joshua Rosenberg and Tobias Adrian are with the Capital Markets Function of the Research and Statistics Group at the Federal Reserve Bank of New York. We would like to thank Robert Stambaugh (the editor), two anonymous referees, John Campbell, Frank Diebold, Robert Engle, Arturo Estrella, Eric Ghysels, Til Schuermann, Kevin Sheppard, Jiang Wang, and Zhenyu Wang for comments. We also thank seminar participants and discussants at the Federal Reserve Bank of New York, the Adam Smith Asset Pricing conference at London Business School, the University of Massachusetts Amherst, the University of Zurich, the Financial Market Risk Premium conference at the Federal Reserve Board, the World Congress of the Econometric Society, the European Finance Association Meeting, the Financial Management Association, Queens University, Harvard Business School, Princeton University, Oak Hill Platinum Partners, and Barclays Global Investors for helpful comments. Alexis Iwanisziw and Ellyn Boukus provided outstanding research assistance. The views expressed in this paper are those of the authors and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System.


We explore the cross-sectional pricing of volatility risk by decomposing equity market volatility into short- and long-run components. Our finding that prices of risk are negative and significant for both volatility components implies that investors pay for insurance against increases in volatility, even if those increases have little persistence. The short-run component captures market skewness risk, which we interpret as a measure of the tightness of financial constraints. The long-run component relates to business cycle risk. Furthermore, a three-factor pricing model with the market return and the two volatility components compares favorably to benchmark models.