Financial Asset Returns, Market Timing, and Volatility Dynamics

32 Pages Posted: 19 Apr 2002

See all articles by Peter Christoffersen

Peter Christoffersen

University of Toronto - Rotman School of Management; Copenhagen Business School; Aarhus University - CREATES

Francis X. Diebold

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: January 2, 2002

Abstract

We consider three sets of phenomena that feature prominently - and separately - in the financial economics literature: conditional mean dependence (or lack thereof) in asset returns, dependence (and hence forecastability) in asset return signs with implications for market timing, and dependence (and hence forecastability) in asset return volatilities. We show that they are very much interrelated, and we explore the relationships in detail. Among other things, we show that: (1) Volatility dependence produces sign dependence, so long as expected returns are nonzero. Hence one should expect sign dependence, given the overwhelming evidence of volatility dependence. (2) The standard finding of little or no conditional mean dependence is entirely consistent with a significant degree of sign dependence and volatility dependence. In particular, sign dependence does not imply market inefficiency. (3) Sign dependence is not likely to be found via analysis of sign autocorrelations, because the nature of sign dependence is highly nonlinear. (4) Sign dependence is not likely to be found in very high-frequency (e.g., daily) or very low-frequency (e.g., annual) returns. Instead, it is more likely to be found at intermediate return horizons.

Keywords: Financial Asset Returns, Market Timing, and Volatility Dynamics

JEL Classification: C52, C53, G14, G12

Suggested Citation

Christoffersen, Peter and Diebold, Francis X., Financial Asset Returns, Market Timing, and Volatility Dynamics (January 2, 2002). Available at SSRN: https://ssrn.com/abstract=306127 or http://dx.doi.org/10.2139/ssrn.306127

Peter Christoffersen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5P 3C4
Canada
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Copenhagen Business School

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Frederiksberg C, DK - 2000
Denmark

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Francis X. Diebold

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-1507 (Phone)
215-573-4217 (Fax)

HOME PAGE: http://www.ssc.upenn.edu/~fdiebold/

National Bureau of Economic Research (NBER)

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