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The Effect of Long Memory in Volatility on Stock Market Fluctuations

  • Bent Jesper Christensen
  • Morten Ørregaard Nielsen

    ()

    (School of Economics and Management, University of Aarhus, Denmark)

Recent empirical evidence demonstrates the presence of an important long memory component in realized asset return volatility. We specify and estimate multivariate models for the joint dynamics of stock returns and volatility that allow for long memory in volatility without imposing this property on returns. Asset pricing theory imposes testable cross- equation restrictions on the system that are not rejected in our preferred specifications, which include a strong financial leverage effect. We show that the impact of volatility shocks on stock prices is small and short-lived, in spite of a positive risk-return trade-off and long memory in volatility.

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Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2007-03.

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Length: 44
Date of creation: 11 May 2007
Date of revision:
Handle: RePEc:aah:create:2007-03
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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