Heterogeneous Volatility Cascade in Financial Markets

Posted: 17 Sep 2001

See all articles by Gilles O. Zumbach

Gilles O. Zumbach

Edgelab; Consulting in Financial Engineering

Paul Lynch

The University of Manchester - School of Electrical & Electronic Engineering

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Abstract

Using high frequency data, we have studied empirically the change of volatility, also called volatility derivative, for various time horizons. In particular, the correlation between the volatility derivative and the volatility realized in the next time period is a measure of the response function of the market participants. This correlation shows explicitly the heterogeneous structure of the market according to the characteristic time horizons of the different agents. It reveals a volatility cascade from long to short time horizons, with a structure different from the one observed in turbulence. Moreover, we have developed a new ARCH-type model which incorporates the different groups of agents, with their characteristic memory. This model reproduces well the empirical response function, and allows us to quantify the importance of each group.

Keywords: Econophysics, Volatility cascade, Market components, ARCH model, Turbulence

JEL Classification: D40, C22, C15

Suggested Citation

Zumbach, Gilles and Lynch, Paul, Heterogeneous Volatility Cascade in Financial Markets. Available at SSRN: https://ssrn.com/abstract=272042

Gilles Zumbach (Contact Author)

Edgelab ( email )

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Consulting in Financial Engineering ( email )

Ch. Charles Baudouin 8
Saconnex d'Arve, 1228
Switzerland
+41 76 4351267 (Phone)

Paul Lynch

The University of Manchester - School of Electrical & Electronic Engineering ( email )

United Kingdom

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