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GARCH-M model with an asymmetric risk premium: Distinguishing between ‘good’ and ‘bad’ volatility periods

Author

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  • Trifonov, Juri
  • Potanin, Bogdan

Abstract

We proposed a new method (GARCH-M-GJR-LEV) that captures the asymmetry in the variance and return equations. The development of the model is encouraged by the stylized fact that investors demand a higher risk premium during “bad” volatility periods rather than “good” ones. To study the properties of the obtained estimators, we conducted simulated data analysis, considering a data-generating process characterized by asymmetric responses of risk premium to volatility changes. As a result, we have found statistical evidence in favor of a significant advantage of the proposed method compared to existing alternatives. Further, the proposed model was applied to study the S&P 500 market index. We have found evidence of an asymmetric relationship between the risk premium and volatility changes during most periods under consideration. Due to this, the GARCH-M-GJR-LEV model usually outperformed the alternative GARCH family models according to the information criteria.

Suggested Citation

  • Trifonov, Juri & Potanin, Bogdan, 2024. "GARCH-M model with an asymmetric risk premium: Distinguishing between ‘good’ and ‘bad’ volatility periods," International Review of Financial Analysis, Elsevier, vol. 91(C).
    • Handle: RePEc:eee:finana:v:91:y:2024:i:c:s105752192300457x
    DOI: 10.1016/j.irfa.2023.102941
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    More about this item

    Keywords

    GARCH; Leverage effect; Risk premium; Conditional volatility;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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