CentER

Juan Miguel Londoño Yarce

Date of PhD defense:	9 December 2011
Title of thesis:	Essays in Asset Pricing
ISBN:	978 90 5668 304 7
Promotor:	Prof.dr. Joost Driessen
Co-promotor:	Dr. Lieven Baele

Abstract:

This dissertation presents three self-contained essays on asset pricing. The first one is my Job market paper called "The variance risk premium around the world". The second one is a joint work with Lieven Baele, Joost Driessen and Oliver Spalt on "Cumulative Prospect Theory and the volatility premium". Finally, the third essay is a joint work with Lieven Baele and is called "Understanding Industry betas". Each essay is summarized in turn.
My first paper investigates the variance risk premium in an international setting. In this paper I first provide new evidence on the basic stylized facts traditionally documented for the US. I show that while the variance premiums in several countries are, on average, positive and display significant time variation, they do not predict local equity returns in countries other than the US. Then, I extend the domestic model in Bollerslev, Tauchen and Zhou (2009) to an international setting. In light of the qualitative implications of my model, I provide empirical evidence that the US variance outperforms all other countries’ variance premiums in predicting local and foreign equity returns.
The second paper explores the ability of Cumulative Prospect Theory (CPT) to explain the observed negative volatility premium embedded in option prices. In this paper, we simulate equilibrium prices for zero-beta straddles when agents are endowed with CPT-type preferences. We find that overweighting the probability of extreme events, one of the components of CPT, plays a key role in increasing the implied price of straddles. In contrast, increasing the scale of the value function, the second component of CPT, yields minor changes in the equilibrium prices of these derivatives unless agents display a very large degree of loss aversion. We also explore these implications in a time-varying framework where we find that the price agents are willing to pay to hedge the risk of extreme events depends on the previous performance of their portfolio.
Finally, the third paper models and explains the dynamics of market betas for 30 US industry portfolios between 1970 and 2009. We use a DCC-MIDAS and kernel regression technique as alternatives to the standard ex-post measures. In this paper, we find betas to exhibit substantial persistence, time variation, ranking variability, and heterogeneity in their business cycle exposure. While we find only a limited amount of structural breaks in the betas of individual industries, we do identify a common structural break in March 1998. Finally, we find the cross-sectional dispersion in industry betas to be countercyclical and negatively related to future market returns.

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