Business Cycle Asymmetries in Stock Returns: Evidence from Higher Order Moments and Conditional Densities

56 Pages Posted: 10 Feb 2003

See all articles by Gabriel Perez-Quiros

Gabriel Perez-Quiros

Banco de España

Allan Timmermann

UCSD ; Centre for Economic Policy Research (CEPR)

Date Written: April 2001

Abstract

Markow switching models with time-varying means, variances and mixing weights are applied to charakterize business cycle variation in the probability distribution and higher order moments of stock returns. This allows us to provide a comprehensive characterization of risk that goes well beyond the mean and variance of returns. Several mixture models with different specifications of the state transition are compared and we propose a new mixture of Gaussian and student-t distributions that captures outliers in returns. The models produce very similar expected returns and volatilities but imply very different time series for conditional skewness, kurtosis and predictive density. Consistent with economic theory, the gains in predictive accuracy from considering two-state mixture models rather than a single-state specification are higher for small firms than for large firms.

Keywords: Markov Switching; Density Modelling; Mixtures of Distributions; Business Cycle risk

JEL Classification: C22, C52

Suggested Citation

Perez-Quiros, Gabriel and Timmermann, Allan, Business Cycle Asymmetries in Stock Returns: Evidence from Higher Order Moments and Conditional Densities (April 2001). Available at SSRN: https://ssrn.com/abstract=356061

Gabriel Perez-Quiros (Contact Author)

Banco de España ( email )

Madrid 28014
Spain

Allan Timmermann

UCSD ( email )

9500 Gilman Drive
La Jolla, CA 92093-0553
United States
858-534-0894 (Phone)

HOME PAGE: http://rady.ucsd.edu/people/faculty/timmermann/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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