Firm Fundamentals and Variance Risk Premiums

• In Event: Expected Earnings and Stock Prices

Abstract

Abstract We develop and empirically test an accounting-based model that ties two firm characteristics, book-to-market (bm) and return on equity (roe), to risk. The model predicts a negative relation between these characteristics and expected variance returns embedded in option prices (variance risk premiums). We confirm the predictions of the model using a variety of empirical specifications. Our results show that accounting data can be used to forecast the returns of assets other than stocks and that accounting data simultaneously inform investors about cash flows as well as the risk of those cash flows.

Authors

• Matthew Lyle, Northwestern University

• James Patrick Naughton, Northwestern University