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The Threshold Effect in Expected Volatility: A Model Based on Asymmetric Information

  • Longin, Francois M
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    This article develops theoretical insight into the threshold effect in expected volatility, which means that large shocks are less persistent in volatility than small shocks. The model uses the Kyle-Admati-Pfleiderer setup with liquidity traders, informed traders, and a market maker. Information is modeled as a GARCH process. It is shown that the GARCH process for information is transformed into a TARCH process (for "threshold GARCH") for the market price changes. Working with information flows allows one to derive implications for trading volume and market liquidity which provide the basis for a more complete test of the model. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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    Article provided by Society for Financial Studies in its journal Review of Financial Studies.

    Volume (Year): 10 (1997)
    Issue (Month): 3 ()
    Pages: 837-69

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    Handle: RePEc:oup:rfinst:v:10:y:1997:i:3:p:837-69
    Contact details of provider: Postal: Oxford University Press, Journals Department, 2001 Evans Road, Cary, NC 27513 USA.
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    Web page: http://www.rfs.oupjournals.org/
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    More information through EDIRC

    Order Information: Web: http://www4.oup.co.uk/revfin/subinfo/

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    1. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    2. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, vol. 48(5), pages 1779-1801, December.
    3. Foster, F Douglas & Viswanathan, S, 1993. "The Effect of Public Information and Competition on Trading Volume and Price Volatility," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 23-56.
    4. Benjamin M. Friedman & Kenneth N. Kuttner, 1988. "Time-Varying Risk Perceptions and the Pricing of Risky Assets," NBER Working Papers 2694, National Bureau of Economic Research, Inc.
    5. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    6. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
    7. Gourieroux Christian & Monfort Alain, 1991. "Qualitative threshold arch models," CEPREMAP Working Papers (Couverture Orange) 9109, CEPREMAP.
    8. Balduzzi, Pierluigi & Kallal, Hedi & Longin, Francois, 1996. "Minimal returns and the breakdown of the price-volume relation," Economics Letters, Elsevier, vol. 50(2), pages 265-269, February.
    9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    10. Conrad, Jennifer & Gultekin, Mustafa N & Kaul, Gautam, 1991. "Asymmetric Predictability of Conditional Variances," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 597-622.
    11. Robert F. Engle & Victor K. Ng, 1991. "Measuring and Testing the Impact of News on Volatility," NBER Working Papers 3681, National Bureau of Economic Research, Inc.
    12. Robert F. Engle & Takatoshi Ito & Wen-Ling Lin, 1988. "Meteor Showers or Heat Waves? Heteroskedastic Intra-Daily Volatility in the Foreign Exchange Market," NBER Working Papers 2609, National Bureau of Economic Research, Inc.
    13. 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.
    14. Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1992. "Stock Prices and Volume," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 199-242.
    15. Ross, Stephen A, 1989. " Information and Volatility: The No-Arbitrage Martingale Approach to Timing and Resolution Irrelevancy," Journal of Finance, American Finance Association, vol. 44(1), pages 1-17, March.
    16. Brennan, Michael J & Jegadeesh, Narasimhan & Swaminathan, Bhaskaran, 1993. "Investment Analysis and the Adjustment of Stock Prices to Common Information," Review of Financial Studies, Society for Financial Studies, vol. 6(4), pages 799-824.
    17. Engle, Robert F. & Mustafa, Chowdhury, 1992. "Implied ARCH models from options prices," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 289-311.
    18. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-55, January.
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