The Volatility-Return Relationship: Insights from Linear and Non-Linear Quantile Regressions
AbstractThis paper examines the asymmetric relationship between price and implied volatility and the associated extreme quantile dependence using a linear and non- linear quantile regression approach. Our goal is to demonstrate that the relationship between the volatility and market return, as quantified by Ordinary Least Square (OLS) regression, is not uniform across the distribution of the volatility-price re-turn pairs using quantile regressions. We examine the bivariate relationships of six volatility-return pairs, namely: CBOE VIX and S&P 500, FTSE 100 Volatility and FTSE 100, NASDAQ 100 Volatility (VXN) and NASDAQ, DAX Volatility (VDAX) and DAX 30, CAC Volatility (VCAC) and CAC 40, and STOXX Volatility (VS-TOXX) and STOXX. The assumption of a normal distribution in the return series is not appropriate when the distribution is skewed, and hence OLS may not capture a complete picture of the relationship. Quantile regression, on the other hand, can be set up with various loss functions, both parametric and non-parametric (linear case) and can be evaluated with skewed marginal-based copulas (for the non-linear case), which is helpful in evaluating the non-normal and non- linear nature of the relationship between price and volatility. In the empirical analysis we compare the results from linear quantile regression (LQR) and copula based non-linear quantile regression known as copula quantile regression (CQR). The discussion of the properties of the volatility series and empirical findings in this paper have significance for portfolio optimization, hedging strategies, trading strategies and risk management, in general.
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Bibliographic InfoPaper provided by Edith Cowan University, School of Business in its series Working papers with number 2012-01.
Length: 25 pages
Date of creation: Jan 2012
Date of revision:
Return Volatility relationship; Quantile regression; Copula; Copula quantile regression; Volatility index; Tail dependence.;
Other versions of this item:
- D.E. Allen & Abhay K Singh & R. Powell & Michael McAleer & James Taylor & Lyn Thomas, 2012. "The Volatility-Return Relationship: Insights from Linear and Non-Linear Quantile Regressions," Documentos del Instituto Complutense de AnÃ¡lisis EconÃ³mico 2012-24, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.
- David E Allen & Abhay K Singh & Robert J Powell & Michael McAleer & James Taylor & Lyn Thomas, 2012. "The Volatility-Return Relationship:Insights from Linear and Non-Linear Quantile Regressions," KIER Working Papers 831, Kyoto University, Institute of Economic Research.
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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