Can someone provide an intuitive understanding of the variance risk premium? I am very confused by this definition and cannot interpret my time series analysis.
Intuitively: empirical research has shown that options on the S&P are priced at a slightly higher implied vol than the actual historical vol of the S&P (on average). Why? Likely this is because holding these options provides insurance against bad states of the economy (volatility increases when the economy is in trouble); this is valuable and raises their price. In any case, the difference between the squared implied vol and the squared historical vol is called the VRP or Variance Risk Premium. The key paper is Bollerslev's in RFS 2009 (cited above by Phun).