Heterogeneous Investment Horizons, Jump Risk and Market Fear

49 Pages Posted: 16 Aug 2017

See all articles by Deniz Erdemlioglu

Deniz Erdemlioglu

IESEG School of Management and CNRS - France

Nikola Gradojevic

University of Guelph, Department of Economics and Finance; University of Bologna - Rimini Center for Economic Analysis (RCEA)

Date Written: February 27, 2017

Abstract

This paper introduces a new empirical framework to identify the regimes of jump-type tail risk over multiple trading horizons. Our approach combines the hidden Markov regime-switching model with realized jumps, which allows us to examine the tail risk exposure of investors at different investment scales. Applying our method to data on bonds, stocks and currencies, we find evidence that market risk linked to jumps exhibits time-varying regime shifts and horizon-dependence. When jump-induced shocks occur at low frequencies, the associated risks are absorbed and stabilized at high frequencies. We also show that high-frequency trading does not contribute to market instability, as measured by jump risk. While the evidence holds for both tail types (right-left), European bond market appears to be more vulnerable to downside (left-tail) jump risk, relative to the U.S. Treasury bond market. Finally, by using the VIX, we demonstrate that market jump fear exhibits vertical clustering where both risk regimes at low frequencies remain unchanged at higher frequencies. These results suggest that the premium for jump risk not only depends on stress periods, but also on the frequency at which investors trade financial assets.

Keywords: Jumps, Volatility, High-frequency data, VIX, Multiple investment scales, Hidden Markov regime-switching models

JEL Classification: C58, G10, G12, G15

Suggested Citation

Erdemlioglu, Deniz and Gradojevic, Nikola, Heterogeneous Investment Horizons, Jump Risk and Market Fear (February 27, 2017). Available at SSRN: https://ssrn.com/abstract=3018814

Deniz Erdemlioglu (Contact Author)

IESEG School of Management and CNRS - France ( email )

3 rue de la Digue
Lille, 59000
France

Nikola Gradojevic

University of Guelph, Department of Economics and Finance ( email )

50 Stone Road East
Guelph, Ontario N1G 2W1
Canada

HOME PAGE: http://https://www.uoguelph.ca/economics/users/nikola-gradojevic

University of Bologna - Rimini Center for Economic Analysis (RCEA) ( email )

Via Patara, 3
Rimini (RN), RN 47900
Italy

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