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The Reactive Volatility Model

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  • Sebastien Valeyre
  • Denis Grebenkov
  • Sofiane Aboura
  • Qian Liu

Abstract

We present a new volatility model, simple to implement, that includes a leverage effect whose return-volatility correlation function fits to empirical observations. This model is able to capture both the "retarded effect" induced by the specific risk, and the "panic effect", which occurs whenever systematic risk becomes the dominant factor. Consequently, in contrast to a GARCH model and a standard volatility estimate from the squared returns, this new model is as reactive as the implied volatility: the model adjusts itself in an instantaneous way to each variation of the single stock price or the stock index price and the adjustment is highly correlated to implied volatility changes. We also test the reactivity of our model using extreme events taken from the 470 most liquid European stocks over the last decade. We show that the reactive volatility model is more robust to extreme events, and it allows for the identification of precursors and replicas of extreme events.

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File URL: http://arxiv.org/pdf/1209.5190
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Paper provided by arXiv.org in its series Papers with number 1209.5190.

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Date of creation: Sep 2012
Date of revision: Apr 2013
Handle: RePEc:arx:papers:1209.5190

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Web page: http://arxiv.org/

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  1. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
  2. John Y. Campbell & Ludger Hentschel, 1991. "No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns," NBER Working Papers 3742, National Bureau of Economic Research, Inc.
  3. Allez, Romain & Bouchaud, Jean-Philippe, 2011. "Individual and collective stock dynamics: intra-day seasonalities," Economics Papers from University Paris Dauphine 123456789/10898, Paris Dauphine University.
  4. Fran├žois Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
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