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P. B. Hsieh: A Forward-Looking Index of Market Variance

April 11, 2025

This paper proposes a forward-looking index as a measure of market variance. We establish a theoretical foundation for this index and demonstrate that it can be constructed in a timely manner using a set of options currently available in the market. Building upon this index, we introduce a forward-looking variance risk premium and analyze its decomposition. Statistical evidence provides robust support for the index as a predictor of realized variance. The empirical findings suggest a positive variance risk premium and indicate that our proposed forward-looking variance risk premium significantly predicts the equity risk premium.

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