Nonparametric Estimation of the Leverage Effect: A Trade-off between Robustness and Efficiency
University of Montreal
University of Chicago - Booth School of Business
November 22, 2015
Chicago Booth Research Paper No. 13-83
We consider two new approaches to nonparametric estimation of the leverage effect. The first approach uses stock prices alone. The second approach uses the data on stock prices as well as a certain volatility instrument, such as the CBOE volatility index (VIX) or the Black-Scholes implied volatility. The theoretical justification for the instrument-based estimator relies on a certain invariance property, which can be exploited when high frequency data is available. The price-only estimator is more robust since it is valid under weaker assumptions. However, in the presence of a valid volatility instrument, the price-only estimator is inefficient as the instrument-based estimator has a faster rate of convergence. We consider two empirical applications, in which we study the relationship between the leverage effect and the debt-to-equity ratio, credit risk, and illiquidity.
Number of Pages in PDF File: 62
Keywords: semimartingale, spot correlation, VIX, implied volatility, high frequency data
JEL Classification: G12, C22, C14
Date posted: November 26, 2013 ; Last revised: November 24, 2015
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