Disentangling Continuous Volatility From Jumps in Long-Run Risk-Return Relationships

49 Pages Posted: 14 Jun 2013

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: June 2013

Abstract

Realized variance can be broken down into continuous volatility and jumps. We show that these two components have very different predictive powers on future long-term excess stock market returns. While continuous volatility is a key driver of medium to long-term risk-return relationships, jumps do not predict future medium to long-term excess returns. We use inference methods robust to persistent predictors in a multi-horizon setup. That is, we use a rescaled Student-t to test for significant risk-return links, give asymptotic arguments, and simulate its exact behavior under the null in the case of multiple regressors with different degrees of persistence. Then, with Wald tests of equality of the risk-return relationship at multiple horizons, we find no evidence against a proportional relationship, constant across horizons, between long-term continuous volatility and future returns. Two by-products of our analysis are that imposing model-based constraints on long term regressions can improve their efficiency, and short-run estimates are sensitive to short-term variability of the predictors.

Keywords: predictability, realized variance, continuous volatility, jumps, long-run returns, persistent regressor

Suggested Citation

Jacquier, Eric and Okou, Cedric, Disentangling Continuous Volatility From Jumps in Long-Run Risk-Return Relationships (June 2013). CIRANO - Scientific Publications 2013s-14, Available at SSRN: https://ssrn.com/abstract=2278323 or http://dx.doi.org/10.2139/ssrn.2278323

Eric Jacquier

Boston University School of Management ( email )

595 Commonwealth Avenue
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HEC Montreal - Department of Finance ( email )

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Canada

Cedric Okou (Contact Author)

University of Quebec at Montreal (UQAM) ( email )

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

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