Stochastic Volatility in General Equilibrium
33 Pages Posted: 24 Aug 2005
Date Written: June 15, 2004
The connections between stock market volatility and returns are studied within the context of a general equilibrium framework. The framework rules out it a priori any purely statistical relationship between volatility and returns by imposing uncorrelated innovations. The main model generates a two-factor structure for stock market volatility along with time-varying risk premiums on consumption and volatility risk. It also generates endogenously a dynamic leverage effect (volatility asymmetry), the sign of which depends upon the magnitudes of the risk aversion and the intertemporal elasticity of substitution parameters.
Keywords: Stochastic volatility, risk aversion, leverage effect, volatility asymmetry
JEL Classification: G12, C51, C52
Suggested Citation: Suggested Citation