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Volatility feedback effect and risk-return tradeoff

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  • Chelikani, Surya
  • Marks, Joseph M.
  • Nam, Kiseok

Abstract

Using the two alternative measures of the ex-ante unexpected volatility shock, we show that the volatility feedback effect plays an important role in the intertemporal risk-return tradeoff. The empirical results indicate that the volatility feedback effect reinforces the positive risk-return relation conditional on bad market news but attenuates the relation under good market news. The results provide strong evidence that an extremely heightened risk-return tradeoff caused by a high level of volatility feedback effect might lead to a market crash, even with no macroeconomic uncertainties in the markets. Also, the results show that the asymmetric volatility feedback effect is attributable to the negative correlation between the concurrent volatility and a price change. The state-dependent volatility feedback effect is observed for different market conditions such as high and low market sentiments and business cycles.

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  • Chelikani, Surya & Marks, Joseph M. & Nam, Kiseok, 2023. "Volatility feedback effect and risk-return tradeoff," The Quarterly Review of Economics and Finance, Elsevier, vol. 92(C), pages 49-65.
    • Handle: RePEc:eee:quaeco:v:92:y:2023:i:c:p:49-65
    DOI: 10.1016/j.qref.2023.08.003
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    More about this item

    Keywords

    Volatility feedback effect; Endogeneity issue; State-dependent risk-return tradeoff; Investor sentiment; Business cycles; VIX;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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