The volatility of cross-sectional stock returns is known to vary over time. Past studies using options have estimated a negative price for market volatility. However, the use of options to estimate price does not control for cross-sectional risk factors, such as book value, size, momentum, or liquidity factors used in previous studies. The authors use cross-sectional stock returns to determine whether market volatility is a priced risk factor and, if so, to estimate the price of aggregate volatility risk using a sample of returns from 1986 to 2000.

The results indicate that market volatility does seem to be a priced factor, such that stocks with high past exposure to changes in aggregate market volatility earn low future returns, on average. To estimate the price of cross-sectional volatility risk, portfolios are formed based on past sensitivity to the VIX Index. The price of volatility risk is estimated at –1 percent annually, and this estimate appears robust to such factors as size, value, momentum, or liquidity. The estimate of a negative price of risk is consistent with a multifactor or intertemporal capital asset pricing model, in which risk-averse investors increase precautionary funds in the presence of future uncertainty. However, the results cannot explain the low average returns to stocks with high exposure to idiosyncratic volatility.