Financial Asset Returns, Market Timing, and Volatility Dynamics
University of Toronto - Rotman School of Management; Copenhagen Business School; University of Aarhus - CREATES
Francis X. Diebold
University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)
January 2, 2002
We consider three sets of phenomena that feature prominently - and separately - in the financial economics literature: conditional mean dependence (or lack thereof) in asset returns, dependence (and hence forecastability) in asset return signs with implications for market timing, and dependence (and hence forecastability) in asset return volatilities. We show that they are very much interrelated, and we explore the relationships in detail. Among other things, we show that: (1) Volatility dependence produces sign dependence, so long as expected returns are nonzero. Hence one should expect sign dependence, given the overwhelming evidence of volatility dependence. (2) The standard finding of little or no conditional mean dependence is entirely consistent with a significant degree of sign dependence and volatility dependence. In particular, sign dependence does not imply market inefficiency. (3) Sign dependence is not likely to be found via analysis of sign autocorrelations, because the nature of sign dependence is highly nonlinear. (4) Sign dependence is not likely to be found in very high-frequency (e.g., daily) or very low-frequency (e.g., annual) returns. Instead, it is more likely to be found at intermediate return horizons.
Number of Pages in PDF File: 32
Keywords: Financial Asset Returns, Market Timing, and Volatility Dynamics
JEL Classification: C52, C53, G14, G12working papers series
Date posted: April 19, 2002
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