Long and Short Run Correlation Risk in Stock Returns



I study the pricing of long and short run variance and correlation risk in the time series of aggregate stock returns and in the cross-section of individual returns. I find that the predictive power of the market variance risk premium for the equity premium is completely driven by the correlation risk premium. Furthermore, I show that long run market volatility risk is priced in the cross-section because of priced innovations in long-term idiosyncratic volatility and shocks to long-term market-wide correlations. In contrast, short run market volatility risk is only priced because of short-term correlation risk.

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Myra Lissenberg