Firm Fundamentals and Variance Risk Premiums

Research output: Working paper

Abstract

We develop a tractable valuation model which shows that future asset returns are predictably related to two firm characteristics, book-to-market (bm) and return on equity (roe), because these measures carry information about priced risk. The model we derive predicts a negative relation between expected variance returns embedded in option prices (variance risk premiums) and both bm and roe. We confirm this prediction using a variety of empirical specifications. Our results show that accounting-based characteristics simultaneously inform investors about cash flows as well as the priced risk of those cash flows.
Original languageEnglish (US)
PublisherSocial Science Research Network (SSRN)
Number of pages55
StatePublished - Jan 18 2016

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Cash flow
Book-to-market
Return on equity
Risk premium
Investors
Firm characteristics
Prediction
Asset returns
Option prices
Valuation model

Cite this

Lyle, M. R., & Naughton, J. P. (2016). Firm Fundamentals and Variance Risk Premiums. Social Science Research Network (SSRN).
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Lyle, MR & Naughton, JP 2016 'Firm Fundamentals and Variance Risk Premiums' Social Science Research Network (SSRN).

Firm Fundamentals and Variance Risk Premiums. / Lyle, Matthew Robert; Naughton, James Patrick.

Social Science Research Network (SSRN), 2016.

Research output: Working paper

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T1 - Firm Fundamentals and Variance Risk Premiums

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AU - Naughton, James Patrick

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N2 - We develop a tractable valuation model which shows that future asset returns are predictably related to two firm characteristics, book-to-market (bm) and return on equity (roe), because these measures carry information about priced risk. The model we derive predicts a negative relation between expected variance returns embedded in option prices (variance risk premiums) and both bm and roe. We confirm this prediction using a variety of empirical specifications. Our results show that accounting-based characteristics simultaneously inform investors about cash flows as well as the priced risk of those cash flows.

AB - We develop a tractable valuation model which shows that future asset returns are predictably related to two firm characteristics, book-to-market (bm) and return on equity (roe), because these measures carry information about priced risk. The model we derive predicts a negative relation between expected variance returns embedded in option prices (variance risk premiums) and both bm and roe. We confirm this prediction using a variety of empirical specifications. Our results show that accounting-based characteristics simultaneously inform investors about cash flows as well as the priced risk of those cash flows.

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Lyle MR, Naughton JP. Firm Fundamentals and Variance Risk Premiums. Social Science Research Network (SSRN). 2016 Jan 18.