Segregating Continuous Volatility from Jumps in Long-Run Risk-Return Trade-Offs

Posted: 8 Mar 2012

See all articles by Eric Jacquier

Eric Jacquier

Boston University School of Management; HEC Montreal - Department of Finance

Cedric Okou

University of Quebec at Montreal (UQAM)

Date Written: February 6, 2012

Abstract

We provide a multi-horizon characterization of the strength of the relationship between market realized variance components, namely continuous volatility and jump, and future market excess return. Building on quadratic variation theory, we find that continuous volatility is a key driver of medium/long-run risk-return trade-offs while jumps lack predictive power to explaining the time variation in medium/long-term excess return. We use inference methods that are robust to persistent predictor in a multi-horizon setup. Specifically, we show that rescaled versions of the usual test statistics converge to non-degenerate distributions in our local-to-unity framework. This study yields evidence supporting a proportional risk-return linkage when jumps are extracted from the quadratic variation activity.

Keywords: stock return predictability, continuous volatility, jumps, long-run, realized volatility

JEL Classification: G12

Suggested Citation

Jacquier, Eric and Okou, Cedric, Segregating Continuous Volatility from Jumps in Long-Run Risk-Return Trade-Offs (February 6, 2012). Available at SSRN: https://ssrn.com/abstract=2018641 or http://dx.doi.org/10.2139/ssrn.2018641

Eric Jacquier

Boston University School of Management ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, QC H3T 2A7
Canada

Cedric Okou (Contact Author)

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada
514-987-3000 Ext. 5521 (Phone)

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