Pricing stock market volatility: Does it matter whether the volatility is related to the business cycle?

Yunmi Kim, Charles R. Nelson

Research output: Contribution to journalArticlepeer-review

10 Scopus citations

Abstract

This article investigates the impact of business cycle-related market volatility on expected returns. We develop a model that enables us to decompose the market volatility into two components: business cycle-related volatility and unrelated volatility. Then, the risk-return relation is assessed based on these two components. Our empirical results demonstrate that business cycle-related market volatility is priced in the stock market, whereas the unrelated component is not. Furthermore, our procedure identifies a few periods of high volatility that are not related to recessions, including the 1987 crash and the 1998 Russian default.

Original languageEnglish
Article numbernbt014
Pages (from-to)307-328
Number of pages22
JournalJournal of Financial Econometrics
Volume12
Issue number2
DOIs
StatePublished - Mar 2014

Keywords

  • Business cycles
  • Expected returns
  • Long-run risk (LRR) asset pricing model
  • Market volatility
  • Markov-switching
  • Risk-return trade-off

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