No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns

50 Pages Posted: 16 Jul 2007 Last revised: 19 Jan 2009

See all articles by John Y. Campbell

John Y. Campbell

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

Ludger Hentschel

Alternative Risk Premia Investments

Date Written: June 1991

Abstract

It is sometimes argued that an increase in stock market volatility raises required stock returns, and thus lowers stock prices. This paper modifies the generalized autoregressive conditionally heteroskedastic (GARCH) model of returns to allow for this volatility feedback effect. The resulting model is asymmetric, because volatility feedback amplifies large negative stock returns and dampens large positive returns, making stock returns negatively skewed and increasing the potential for large crashes. The model also implies that volatility feedback is more important when volatility is high. In U.S. monthly and daily data in the period 1926-88, the asymmetric model fits the data better than the standard GARCH model, accounting for almost half the skewness and excess kurtosis of standard monthly GARCH residuals. Estimated volatility discounts on the stock market range from 1% in normal times to 13% after the stock market crash of October 1987 and 25% in the early 1930's. However volatility feedback has little effect on the unconditional variance of stock returns.

Suggested Citation

Campbell, John Y. and Hentschel, Ludger, No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns (June 1991). NBER Working Paper No. w3742. Available at SSRN: https://ssrn.com/abstract=473923

John Y. Campbell (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Ludger Hentschel

Alternative Risk Premia Investments ( email )

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