Moment Risk Premia and Stock Return Predictability

We study the predictive power of option-implied moment risk premia embedded in the conventional variance risk premium. We find that although the second-moment risk premium predicts market returns in short horizons with positive coefficients, the third-moment (fourth-moment) risk premium predicts market returns in medium horizons with negative (positive) coefficients. Combining the higher-moment risk premia with the second-moment risk premium improves the stock return predictability over multiple horizons, both in sample and out of sample. The finding is economically significant in an asset-allocation exercise and survives a series of robustness checks.

Automated summary

This study examines the predictive power of option-implied moment risk premia and finds that different moments have different effects on market returns. Combining higher-moment risk premia with the second-moment risk premia improves the predictability of stock returns.