Financial connectedness among European volatility risk premia

In this paper we use the Diebold Yilmaz (2009 and 2012) methodology to estimate thecontribution and the vulnerability to systemic risk of volatility risk premia for five European stockmarkets: France, Germany, UK, Switzerland and the Netherlands. The volatility risk premium, whichis a proxy of risk aversion, is measured by the difference between the implied volatility and expectedrealized volatility of the stock market for next month. While Diebold and Yilmaz focus is on theforecast error variance decomposition of stock returns or range based volatilities employing astationary VAR in levels, we account for the (locally) long memory stationary properties of the levelsof volatility risk premia series. Therefore, we estimate and invert a Fractionally Integrated VARmodel to compute the cross forecast error variance shares necessary to obtain the index of total anddirectional connectedness.