Why are stock returns and volatility negatively correlated?

Jinho Bae, Chang Jin Kim, Charles R. Nelson

Research output: Contribution to journalArticle

49 Citations (Scopus)

Abstract

The literature documents that low stock returns are associated with increased volatility, but two competing explanations have proved difficult to disentangle. A negative return increases leverage, making equity value more volatile. However, an increase in volatility that persists causes stock prices to drop. We follow Bekaert and Wu [Bekaert, G., Wu, G., 2000. Asymmetric volatility and risk in equity markets. Review of Financial Studies 13, 1-42.] in controlling for leverage, but distinguish between volatility regimes that persist from less persistent changes using GARCH. For post-World War II returns on the value-weighted portfolio of all NYSE stocks, we find that changes in the volatility regime are reflected in stock returns but not in GARCH.

Original languageEnglish
Pages (from-to)41-58
Number of pages18
JournalJournal of Empirical Finance
Volume14
Issue number1
DOIs
Publication statusPublished - 2007 Jan

Keywords

  • Asymmetric volatility
  • GARCH
  • Leverage effect
  • Regime switching
  • Volatility feedback

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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