The Effect of Long Memory in Volatility on Stock Market Fluctuations

Bent Jesper Christensen, Morten Ørregaard Nielsen

    Research output: Working paper/Preprint Working paperResearch

    Abstract

    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.
    Original languageEnglish
    Place of publicationAarhus
    PublisherCREATES, Institut for Økonomi, Aarhus Universitet
    Number of pages44
    Publication statusPublished - 2007

    Keywords

    • Financial leverage, long memory, realized volatility, risk-return trade-o¤, sto-

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