Why are Stock Returns and Volatility Negatively Correlated?

42 Pages Posted: 23 Sep 2004

See all articles by Jinho Bae

Jinho Bae

Konkuk University

Chang-Jin Kim

Korea University; Dept. of Economics, University of Washington

Charles R. Nelson

Dept of Economics

Date Written: August 2004

Abstract

The literature documents that low stock returns are associated with increased volatility, but two competing explanations have proved difficult to disentangle. A negative return increases leverage making equity value more volatile. However, volatility feedback increases the risk premium when a surprise rise in volatility is expected to persist. We follow Bekaert and Wu (2000) in controlling for leverage, but distinguish between volatility regimes that persist from less persistent changes using GARCH. Supporting volatility feedback, we find changes in volatility regime are reflected in stock returns, but not GARCH. Further, variation in leverage is not important in explaining volatility dynamics.

Keywords: Asymmetric volatility, volatility reedback, leverage effect, regime switching, GARCH

JEL Classification: C32, C51, G12

Suggested Citation

Bae, Jinho and Kim, Chang-Jin and Nelson, Charles R., Why are Stock Returns and Volatility Negatively Correlated? (August 2004). Available at SSRN: https://ssrn.com/abstract=594281 or http://dx.doi.org/10.2139/ssrn.594281

Jinho Bae

Konkuk University ( email )

1, Hwayang-dong
Gwangjin-gu
Seoul, 143-071
Korea
82-2-450-3646 (Phone)
82-2-446-3615 (Fax)

Chang-Jin Kim

Korea University ( email )

Anam-dong, Sungbuk-Ku
Dept. of Economics, Korea University
Seoul 136-701
Korea

HOME PAGE: http://econ.korea.ac.kr/~cjkim/

Dept. of Economics, University of Washington ( email )

Department of Economics (Box 353330)
University of Washington
Seattle, WA 98195-3330
United States

HOME PAGE: http://econ.korea.ac.kr/~cjkim/

Charles R. Nelson (Contact Author)

Dept of Economics ( email )

Box 353330
Seattle, WA 98195-3330
United States

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