The Effect of Long Memory in Volatility on Stock Market Fluctuations

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  • Institut for Økonomi
Recent empirical evidence demonstrates the presence of an important long memory component in realized asset return volatility. We specify and estimate multivariate models for the joint dynamics of stock returns and volatility that allow for long memory in volatility without imposing this property on returns. Asset pricing theory imposes testable cross-equation restrictions on the system that are not rejected in our preferred specifications, which include a strong financial leverage effect. We show that the impact of volatility shocks on stock prices is small and short-lived, in spite of a positive risk-return trade-off and long memory in volatility.
OriginalsprogEngelsk
TidsskriftReview of Economics and Statistics
Vol/bind89
Nummer4
Sider (fra-til)684-700
Antal sider17
ISSN0034-6535
StatusUdgivet - 2007

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