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Risk and return: Long-run relations, fractional cointegration, and return predictability

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  • Bollerslev, Tim
  • Osterrieder, Daniela
  • Sizova, Natalia
  • Tauchen, George

Abstract

Univariate dependencies in market volatility, both objective and risk neutral, are best described by long-memory fractionally integrated processes. Meanwhile, the ex post difference, or the variance swap payoff reflecting the reward for bearing volatility risk, displays far less persistent dynamics. Using intraday data for the Standard & Poor's 500 and the volatility index (VIX), coupled with frequency domain methods, we separate the series into various components. We find that the coherence between volatility and the volatility-risk reward is the strongest at long-run frequencies. Our results are consistent with generalized long-run risk models and help explain why classical efforts of establishing a naïve return-volatility relation fail. We also estimate a fractionally cointegrated vector autoregression (CFVAR). The model-implied long-run equilibrium relation between the two variance variables results in nontrivial return predictability over interdaily and monthly horizons, supporting the idea that the cointegrating relation between the two variance measures proxies for the economic uncertainty rewarded by the market.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 108 (2013)
Issue (Month): 2 ()
Pages: 409-424

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Handle: RePEc:eee:jfinec:v:108:y:2013:i:2:p:409-424

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Web page: http://www.elsevier.com/locate/inca/505576

Related research

Keywords: High-frequency data; Realized and options implied volatilities; Volatility risk premium; Long-memory and fractional cointegration; Return predictability;

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References

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Cited by:
  1. Niels Haldrup & Robinson Kruse, 2014. "Discriminating between fractional integration and spurious long memory," CREATES Research Papers 2014-19, School of Economics and Management, University of Aarhus.
  2. Tse, Chin-Bun & Rodgers, Timothy & Niklewski, Jacek, 2014. "The 2007 financial crisis and the UK residential housing market: Did the relationship between interest rates and house prices change?," Economic Modelling, Elsevier, vol. 37(C), pages 518-530.
  3. Andrea Cipollini & Iolanda Lo Cascio & Silvia Muzzioli, 2013. "Volatility co-movements: a time scale decomposition analysis," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 13111, Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi".

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