Heterogeneous Investment Horizons, Jump Risk and Market Fear
49 Pages Posted: 16 Aug 2017
Date Written: February 27, 2017
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: Suggested Citation