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No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns

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  • John Y. Campbell
  • Ludger Hentschel

Abstract

It is sometimes argued that an increase in stock market volatility raises required stock returns, and thus lowers stock prices. This paper modifies the generalized autoregressive conditionally heteroskedastic (GARCH) model of returns to allow for this volatility feedback effect. The resulting model is asymmetric, because volatility feedback amplifies large negative stock returns and dampens large positive returns, making stock returns negatively skewed and increasing the potential for large crashes. The model also implies that volatility feedback is more important when volatility is high. In U.S. monthly and daily data in the period 1926-88, the asymmetric model fits the data better than the standard GARCH model, accounting for almost half the skewness and excess kurtosis of standard monthly GARCH residuals. Estimated volatility discounts on the stock market range from 1% in normal times to 13% after the stock market crash of October 1987 and 25% in the early 1930's. However volatility feedback has little effect on the unconditional variance of stock returns.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3742.

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Date of creation: Jun 1991
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Publication status: published as Journal of Financial Economics vol. 31, 1992, p. 281-318
Handle: RePEc:nbr:nberwo:3742

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  1. Akgiray, Vedat, 1989. "Conditional Heteroscedasticity in Time Series of Stock Returns: Evidence and Forecasts," The Journal of Business, University of Chicago Press, vol. 62(1), pages 55-80, January.
  2. Sentana,E., 1995. "Quadratic Arch Models," Papers, Centro de Estudios Monetarios Y Financieros- 9517, Centro de Estudios Monetarios Y Financieros-.
  3. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, Econometric Society, vol. 53(2), pages 385-407, March.
  4. Adrian R. Pagan & G. William Schwert, 1990. "Alternative Models For Conditional Stock Volatility," NBER Working Papers 2955, National Bureau of Economic Research, Inc.
  5. Robert S. Pindyck, 1983. "Risk, Inflation, and the Stock Market," NBER Working Papers 1186, National Bureau of Economic Research, Inc.
  6. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
  7. Christie, Andrew A., 1982. "The stochastic behavior of common stock variances : Value, leverage and interest rate effects," Journal of Financial Economics, Elsevier, vol. 10(4), pages 407-432, December.
  8. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, Econometric Society, vol. 59(2), pages 347-70, March.
  9. Turner, C.M. & Startz, R. & Nelson, C.R., 1989. "The Markov Model Of Heteroskedasticity, Risk And Learning In The Stock Market," Discussion Papers in Economics at the University of Washington, Department of Economics at the University of Washington 89-01, Department of Economics at the University of Washington.
  10. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  11. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
  12. Turner, Christopher M. & Startz, Richard & Nelson, Charles R., 1989. "A Markov model of heteroskedasticity, risk, and learning in the stock market," Journal of Financial Economics, Elsevier, vol. 25(1), pages 3-22, November.
  13. David H. Cutler & James M. Poterba & Lawrence H. Summers, 1988. "What Moves Stock Prices?," Working papers 487, Massachusetts Institute of Technology (MIT), Department of Economics.
  14. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
  15. Schwert, G William, 1990. "Stock Volatility and the Crash of '87," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 77-102.
  16. Engle, Robert F & Gonzalez-Rivera, Gloria, 1991. "Semiparametric ARCH Models," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 9(4), pages 345-59, October.
  17. Lars Peter Hansen & Thomas J. Sargent, 1981. "A note on Wiener-Kolmogorov prediction formulas for rational expectations models," Staff Report, Federal Reserve Bank of Minneapolis 69, Federal Reserve Bank of Minneapolis.
  18. Benjamin M. Friedman & David I. Laibson, 1989. "Economic Implications of Extraordinary Movements in Stock Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(2), pages 137-190.
  19. Chou, Ray Yeutien, 1988. "Volatility Persistence and Stock Valuations: Some Empirical Evidence Using Garch," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 3(4), pages 279-94, October-D.
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