Nonparametric Estimation of the Leverage Effect: A Trade-off between Robustness and Efficiency

62 Pages Posted: 26 Nov 2013 Last revised: 24 Nov 2015

Ilze Kalnina

University of Montreal

Dacheng Xiu

University of Chicago - Booth School of Business

Date Written: November 22, 2015

Abstract

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.

Keywords: semimartingale, spot correlation, VIX, implied volatility, high frequency data

JEL Classification: G12, C22, C14

Suggested Citation

Kalnina, Ilze and Xiu, Dacheng, Nonparametric Estimation of the Leverage Effect: A Trade-off between Robustness and Efficiency (November 22, 2015). Chicago Booth Research Paper No. 13-83. Available at SSRN: https://ssrn.com/abstract=2360256 or http://dx.doi.org/10.2139/ssrn.2360256

Ilze Kalnina

University of Montreal ( email )

C.P. 6128 succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

Dacheng Xiu (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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