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The Effect of Long Memory in Volatility on Stock Market Fluctuations

Research output: Working paperResearch

  • Bent Jesper Christensen
  • Morten Ørregaard Nielsen, Department of Economics, Cornell University, New York, United States
  • Afdeling for Virksomhedsledelse
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
PublisherInstitut for Økonomi, Aarhus Universitet
Publication statusPublished - 2005

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