Do Jumps Contribute to the Dynamics of the Equity Premium?∗

This paper investigates whether risks associated with time-varying arrival of jumps and their effect on the dynamics of higher moments of returns are priced in the conditional mean of daily market excess returns. We find that jumps and jump dynamics are significantly related to the market equity premium. The results from our time-series approach reinforce the importance of the skewness premium found in cross-sectional studies using lower-frequency data; and offer a potential resolution to sometimes conflicting results on the intertemporal risk-return relationship. We use a general utility specification, consistent with our pricing kernel, to evaluate the relative value of alternative risk premium models in an out-of-sample portfolio performance application. ∗The authors are grateful to Peter Christoffersen, George Constantinides, Redouane Elkamhi, Massimo Guidolin, Neil Pearson, Lukasz Pomorski and Liyan Yang, as well as participants at the 22 Annual Conference on Financial Economics and Accounting (CFEA) at Indiana University, the 2011 Desautels-HEC-Rotman Winter Finance Workshop, the Faculty of Business, Brock University, and the 2011 Workshop on Time Series and Financial Econometrics at Bocconi University, for valuable comments. We also thank the Social Sciences and Humanities Research Council of Canada for financial support. †Department of Economics, University of Toronto and RCEA Italy, [email protected] ‡Rotman School of Managment, University of Toronto and CIRANO, [email protected] §Rotman School of Management, University of Toronto, [email protected]