Evidence on the Economics of Equity Return Volatility Clustering
AbstractThe underlying economic sources of volatility clustering in asset returns remain a puzzle in financial economics. Using daily equity returns, we study variation in the volatility relation between the conditional variance of individual firm returns and yesterday's market return shock. We find a number of regularities in this market-to-firm volatility relation. (1) It decreases following macroeconomic news announcements; (2) it does not change systematically during the high-news months when firms announce quarterly earnings; and (3) it increases substantially with our measures of dispersion-in-beliefs across traders about the market's common-factor signal. Our evidence suggests that volatility-clustering is a natural result of a price formation process with heterogeneous beliefs across traders, and that volatility clustering is not attributable to an autocorrelated news-generation process around public information such as macroeconomic news releases or firms' earnings releases. We find consistent results in our sample of large-capitalization firms in Japan and the U.K., which suggests a generality of our results and bolsters our economic interpretation.
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