Predicting Market Returns Using Covariance Asymmetry Risk Premium

Implied covariance asymmetry is a market-wide measure defined as the average of the absolute difference between the downside and upside pairwise co-movements of individual stocks, estimated from options data. Its risk premium is linked to improved long-term economic conditions and significantly forecasts excess market returns from 1 month to 2 years. This predictive power persists at horizons beyond 6 months after controlling for popular financial and economic predictors in in-sample analyses. It also translates into superior out-of-sample forecasts and substantial economic gains for a mean-variance investor, particularly over medium and long horizons.