A Permanent and Transitory Component Model of Stock Return Volatility

Posted: 27 Dec 1998  

Gary G. J. Lee

University of California, San Diego (UCSD) - Department of Economics

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: October 1993

Abstract

In this paper, we develop a statistical unobserved component model for stock market volatility. The volatility, which is measured by the conditional variance of stock returns, is decomposed into a permanent or long-run and a transitory or short-run component. The transitory component is mean- reverting towards the trend component. Analysis of US and Japanese stock data supports the decomposition and reinforce the common finding in the literature of persistent stock return volatility. The component model is successful in describing the effect of the "October 87 Crash" on stock volatility changes. We hypothesize that the leverage effect as discussed in Black (1976) and Christie (1982) is a short- run phenomenon in the stock market and there is no asymmetric structure of volatility in the long run. The data strongly supports this hypothesis for US and Japanese stock indices.

JEL Classification: G1

Suggested Citation

Lee, Gary G. J. and Engle, Robert F., A Permanent and Transitory Component Model of Stock Return Volatility (October 1993). Available at SSRN: https://ssrn.com/abstract=5848

Gary G. J. Lee

University of California, San Diego (UCSD) - Department of Economics

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

Robert F. Engle (Contact Author)

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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