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What Ties Return Volatilities to Price Valuations and Fundamentals?

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  • Alexander David
  • Pietro Veronesi
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    Abstract

    The relation between the volatility of stocks and bonds and their price valuations is strongly time-varying, both in magnitude and direction, defying traditional asset pricing models and conventional wisdom. We construct and estimate a model in which investors' learning about regular and unusual fundamental states leads to a non-monotonic V-shaped relation between volatilities and prices. Structural forecasts from our model predict future return volatility and covariances with R2 ranging between 40% and 60% at the 1-year horizon. The model's success stems largely from backing out the endogenous and time-varying pro (counter) cyclical weights that investors assign to earnings (inflation) news.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15563.

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    Date of creation: Dec 2009
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    Handle: RePEc:nbr:nberwo:15563

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    Cited by:
    1. John M. Maheu & Thomas H. McCurdy & Yong Song, 2012. "Components of Bull and Bear Markets: Bull Corrections and Bear Rallies," Journal of Business & Economic Statistics, American Statistical Association, vol. 30(3), pages 391-403, July.
    2. Andrew Ang & Allan Timmermann, 2011. "Regime Changes and Financial Markets," NBER Working Papers 17182, National Bureau of Economic Research, Inc.
    3. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    4. Yiqun Mou & Lars A. Lochstoer & Michael Johannes, 2011. "Learning about Consumption Dynamics," 2011 Meeting Papers 306, Society for Economic Dynamics.

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