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Threshold Asymmetries in Equity Return Distributions: Statistical Tests and Investment Implications

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  • Yoldas Emre

    () (Federal Reserve Board)

Abstract

In this paper we investigate asymmetries in time-varying means, volatilities, correlations, and betas of equity returns in a multivariate threshold framework. We consider alternative specifications in which the threshold variable is based on well established equity pricing factors and predictors. We find strong threshold effects with respect to market excess return, value premium, and term spread. Our results indicate that the threshold model based on the market excess return provides a flexible and computationally inexpensive specification for modeling asymmetries. We test significance of specific forms of asymmetries using subsampling methods. We compare performance of the proposed threshold model with a variety of alternatives in an out-of-sample setup and find that the threshold model performs remarkably well, especially for investors with relatively high risk aversion.

Suggested Citation

  • Yoldas Emre, 2012. "Threshold Asymmetries in Equity Return Distributions: Statistical Tests and Investment Implications," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 16(5), pages 1-37, December.
  • Handle: RePEc:bpj:sndecm:v:16:y:2012:i:5:p:1-37:n:2
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    References listed on IDEAS

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    1. Jun Tu, 2010. "Is Regime Switching in Stock Returns Important in Portfolio Decisions?," Management Science, INFORMS, vol. 56(7), pages 1198-1215, July.
    2. Bekaert, Geert & Wu, Guojun, 2000. "Asymmetric Volatility and Risk in Equity Markets," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 1-42.
    3. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-686, May.
    4. Lorenzo Cappiello & Robert F. Engle & Kevin Sheppard, 2006. "Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(4), pages 537-572.
    5. Ang, Andrew & Chen, Joseph, 2002. "Asymmetric correlations of equity portfolios," Journal of Financial Economics, Elsevier, vol. 63(3), pages 443-494, March.
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