Modelling Regime-Specific Stock Price Volatility

37 Pages Posted: 20 Oct 2009

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School

Emese Lazar

University of Reading - ICMA Centre

Date Written: 0000

Abstract

Single-state generalized autoregressive conditional heteroscedasticity (GARCH) models identify only one mechanism governing the response of volatility to market shocks, and the conditional higher moments are constant, unless modelled explicitly. So they neither capture state-dependent behaviour of volatility nor explain why the equity index skew persists into long-dated options. Markov switching (MS) GARCH models specify several volatility states with endogenous conditional skewness and kurtosis; of these the simplest to estimate is normal mixture (NM) GARCH, which has constant state probabilities. We introduce a state-dependent leverage effect to NM-GARCH and thereby explain the observed characteristics of equity index returns and implied volatility skews, without resorting to time-varying volatility risk premia. An empirical study on European equity indices identifies two-state asymmetric NM-GARCH as the best fit of the 15 models considered. During stable markets volatility behaviour is broadly similar across all indices, but the crash probability and the behaviour of returns and volatility during a crash depends on the index. The volatility mean-reversion and leverage effects during crash markets are quite different from those in the stable regime.

Suggested Citation

Alexander, Carol and Lazar, Emese, Modelling Regime-Specific Stock Price Volatility (0000). Oxford Bulletin of Economics and Statistics, Vol. 71, Issue 6, pp. 761-797, December 2009. Available at SSRN: https://ssrn.com/abstract=1490398 or http://dx.doi.org/10.1111/j.1468-0084.2009.00563.x

Carol Alexander

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom

HOME PAGE: http://www.carolalexander.org

Emese Lazar

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom
+44 (0)1183 786675 (Phone)
+44 (0)1189 314741 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
2
Abstract Views
468
PlumX Metrics