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

Yunmi Kim; Charles R. Nelson

doi:10.1093/jjfinec/nbt014

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

Yunmi Kim, Charles R. Nelson

School of Economics

University of Washington

Research output: Contribution to journal › Article › peer-review

11 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 language	English
Article number	nbt014
Pages (from-to)	307-328
Number of pages	22
Journal	Journal of Financial Econometrics
Volume	12
Issue number	2
DOIs	https://doi.org/10.1093/jjfinec/nbt014
State	Published - 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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10.1093/jjfinec/nbt014

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

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.",

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AB - 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.

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

Abstract

Keywords

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