Aarhus Universitets segl

The impact of financial crises on the risk-return tradeoff and the leverage effect

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We investigate the impact of fi…nancial crises on two fundamental features of stock returns, namely, the risk-return tradeoff and the leverage effect. We apply the fractionally integrated exponential GARCH-in-mean (FIEGARCH-M) model for daily stock return data, which includes both features and allows the co-existence of long memory in volatility and short memory in returns. We extend this model to allow the …financial parameters governing the volatility-in-mean effect and the leverage effect to change during fi…nancial crises. An application to the daily U.S. stock index return series from 1926 through 2010 shows that both …financial effects increase signi…cantly during crises. Strikingly, the risk-return tradeoff is signi…cantly positive only during financial crises, and insigni…cant during non-crisis periods. The leverage effect is negative throughout, but increases signi…cantly by about 50% in magnitude during …financial crises. No such changes are observed during NBER recessions, so in this sense …financial crises are special. Applications to a number of major developed and emerging international stock markets confi…rm the increase in the leverage effect, whereas the international evidence on the risk-return tradeoff is mixed.
UdgiverInstitut for Økonomi, Aarhus Universitet
Antal sider26
StatusUdgivet - 2012


  • FIEGARCH-M, fi…nancial crises, fi…nancial leverage, international markets, long memory, risk-return tradeoff, stock returns, volatility feedback

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