(with Maria Teresa Gonzalez-Perez)
We analyze the term structure of the variance risk premium (VRP). Our empirical study combines the information contained in the Chicago Board Options Exchange (CBOE) volatility index (VIX) constructed over different horizons and high frequency observations on the S&P500 index futures. We find that both VIX and VRP respond nonlinearly to the movements in volatility. Their dynamics depend upon two economically interpretable factors. The first factor captures the economic uncertainty at the business cycle frequency. The second factor reproduces short-lived economic uncertainty. Our results show that the decomposition of the total variation into a persistent and a transitory factor is central to correctly interpreting how the compensation varies over time (VRP) and over different horizons (VRP term structure). We further show that both the thirty day VRP and the VRP term structure predict future excess returns.