Rights statement: This is the peer reviewed version of the following article: Li, Z, Izzeldin, M, Yao, X. Return predictability of variance differences: A fractionally cointegrated approach. J Futures Markets. 2020; 40: 1072– 1089. https://doi.org/10.1002/fut.22110 which has been published in final form athttps://onlinelibrary.wiley.com/doi/abs/10.1002/fut.22110 This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.
Accepted author manuscript, 460 KB, PDF document
Available under license: CC BY-NC: Creative Commons Attribution-NonCommercial 4.0 International License
Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
<mark>Journal publication date</mark> | 1/07/2020 |
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<mark>Journal</mark> | Journal of Futures Markets |
Issue number | 7 |
Volume | 40 |
Number of pages | 18 |
Pages (from-to) | 1072-1089 |
Publication Status | Published |
Early online date | 27/03/20 |
<mark>Original language</mark> | English |
This paper examines the fractional cointegration between downside (upside) components of realized and implied variances. A positive association is found between the strength of their cofractional relation and the return predictability of their differences. That association is established via the common long-memory component of the variances that are fractionally cointegrated, which represents the volatility-of-volatility factor that determines the variance premium. Our results indicate that market fears play a critical role not only in driving the long-run equilibrium relationship between implied-realized variances but also in understanding the return predictability. A simulation study further verifies these claims.