The Asymmetric Effect of the Business Cycle on the Realtion between Stock Market Returns and their Volatility
AbstractWe examine the relation between US stock market returns and the US business cycle for the period 1960 - 2003 using a new methodology that allows us to estimate a time-varying equity premium. We identify two channels in the transmission mechanism. One is through the mean of stock returns via the equity risk premium, and the other is through the volatility of returns. We provide support for previous findings based on simple correlation analysis that the relation is asymmetric with downturns in the business cycle having a greater negative impact on stock returns than the positive effect of upturns. We also obtain a new result, that demand and supply shocks affect stock returns differently. Our model of the relation between returns and their volatility encompasses CAPM, consumption CAPM and Merton's (1973) inter-temporal CAPM. It is implemented using a multi-variate GARCH-in-mean model with an asymmetric time-varying conditional heteroskedasticity and correlation structure.
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Bibliographic InfoPaper provided by Department of Economics, University of York in its series Discussion Papers with number 06/04.
Date of creation: Jan 2006
Date of revision:
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Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
Phone: (0)1904 323776
Fax: (0)1904 323759
Web page: http://www.york.ac.uk/economics/
More information through EDIRC
Equity returns; risk premium; asymmetry;
Other versions of this item:
- P.N. Smith & S. Sorensen & M.R. Wickens, 2006. "The Asymmetric Effect Of The Business Cycle On The Relation Between Stock Market Returns And Their Volatility," CAMA Working Papers 2006-05, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
- Peter N Smith & S Sorensen & M R Wickens, 2005. "The asymmetric effect of the business cycle on the relation between stock market returns and their volatility," Money Macro and Finance (MMF) Research Group Conference 2005 47, Money Macro and Finance Research Group.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-01-29 (All new papers)
- NEP-FIN-2006-01-29 (Finance)
- NEP-FMK-2006-01-29 (Financial Markets)
- NEP-MAC-2006-01-29 (Macroeconomics)
- NEP-RMG-2006-01-29 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Mike R Wickens & Peter N Smith, .
"Macroeconmic Sources of FOREX Risk,"
01/13, Department of Economics, University of York.
- P N Smith & S Sorensen & M R Wickens, .
"Macroeconomic Sources of Equity Risk,"
03/13, Department of Economics, University of York.
- P N Smith & S Sorensen & M R Wickens, . "An Asset Market Integration Test Based on Observable Macroeconomic Stochastic Discount Factors," Discussion Papers 03/14, Department of Economics, University of York.
- Renatas Kizys & Peter Spencer, 2007. "Assessing the Relation between Equity Risk Premia and Macroeconomic Volatilities," Money Macro and Finance (MMF) Research Group Conference 2006 140, Money Macro and Finance Research Group.
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