Trading with Asymmetric Volatility Spillovers
University of Valencia Financial Economics Working Paper
38 Pages Posted: 6 Oct 2003
Date Written: January 2005
We study the profitability of trading strategies based on volatility spillovers between large and small firms. By using the Volatility Impulse-Response Function of Lin (1997) and its extensions, we detect that any volatility shock coming from small companies is important to large companies, but the reverse is only true for negative shocks coming from large firms. To exploit these asymmetric patterns in volatility, different trading rules have been designed based on the inverse relationship existing between expected return and volatility. We find that most strategies generate excess after-transaction profits, especially after very bad news and very good news coming from large or small firm markets. These results are of special interest because of implications for risk and portfolio management.
Keywords: Asymmetric Volatility Spillovers, Feedback effect, Large and small firms, IBEX-35, Trading rules
JEL Classification: G11
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