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Volatility components, leverage effects, and the return-volatility relations

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  • Li, Junye
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    Abstract

    This paper investigates the risk-return trade-off by taking into account the model specification problem. Market volatility is modeled to have two components, one due to the diffusion risk and the other due to the jump risk. The model implies Merton's ICAPM in the absence of leverage effects, whereas the return-volatility relations are determined by interactions between risk premia and leverage effects in the presence of leverage effects. Empirically, I find a robust negative relationship between the expected excess return and the jump volatility and a robust negative relationship between the expected excess return and the unexpected diffusion volatility. The latter provides an indirect evidence of the positive relationship between the expected excess return and the diffusion volatility.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 35 (2011)
    Issue (Month): 6 (June)
    Pages: 1530-1540

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    Handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1530-1540

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Volatility components Risk premia Leverage effects Return-risk trade-off Bayesian methods;

    References

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    Cited by:
    1. Cordis, Adriana S. & Kirby, Chris, 2014. "Discrete stochastic autoregressive volatility," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 160-178.
    2. Harris, Richard D.F. & Stoja, Evarist & Yilmaz, Fatih, 2011. "A cyclical model of exchange rate volatility," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3055-3064, November.
    3. Li, Junye, 2012. "Option-implied volatility factors and the cross-section of market risk premia," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 249-260.

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