Stocks with high uncertainty about risk, as measured by the volatility of expected volatility (vol-of-vol), robustly underperform stocks with low uncertainty about risk by 8% per year. This vol-of-vol effect is distinct from (combinations of) at least 20 previously documented return predictors, survives many robustness checks, and holds in the United States and across European stock markets. We empirically explore the pricing mechanism behind the vol-of-vol effect. The evidence points toward preference-based explanations and away from alternative explanations. Collectively, our results show that uncertainty about risk is highly relevant for stock prices.
This paper has benefited greatly from extensive discussions with Jules van Binsbergen, Menachem Brenner, Stephen Brown, George Constantinides, Zhi Da, Wayne Ferson, Mark Grinblatt, Arthur Korteweg, Tyler Shumway, Aurelio Vasquez, Peter Wakker, Robert Whitelaw, Jeffrey Wurgler, and Hao Zhou. We also thank Nusret Cakici (the referee), Paul Malatesta (the editor), and conference participants and discussants at the 2012 Eastern Finance Association Meeting, the 2012 European Finance Association Meeting, the 2013 American Finance Association Meeting, and the 2013 Luxembourg Asset Management Summit. Baltussen and van Bekkum gratefully acknowledge financial support from the Tinbergen Institute, the Erasmus Research Institute of Management, and the Erasmus Trustfonds. van Bekkum also gratefully acknowledges financial support from the Niels Stensen Foundation. Part of this research project was completed when either Baltussen or van Bekkum was at New York University.
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