Nonlinear Adjustments of Volatility Expectations to Forecast Errors: Evidence from Markov-Regime Switches in Implied Volatility

Kazuhiko Nishina, Nabil Maghrebi and Mark Holmes ()
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Kazuhiko Nishina: Faculty of Economics, Meiji Gakuin University, Japan;
Nabil Maghrebi: Graduate School of Economics, Wakayama University, Japan;

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2012, vol. 15, issue 03, 1-23

Abstract: This paper tests for nonlinearities in the behavior of volatility expectations based on model-free implied volatility indices. Using Markov regime-switching models, the empirical evidence from the German, Japanese and U.S. markets suggests that there are indeed regime-specific levels of volatility expectations. Whereas the regimes seem to be governed by the degree of serial correlation and adjustment to forecast errors, there is no evidence of significant leverage effects. The frequency of regime shifts in volatility expectations is affected by the onset of financial crises, which have the effect of increasing the likelihood of regimes driven by lower autoregressive effects and faster speeds of adjustment. The evidence suggests that despite the heterogeneous beliefs of market participants, implied volatility indices provide a measure of consensus expectations that can be useful in understanding the nonlinear behavior of volatility expectations during periods of financial instability.

Keywords: Markov-Regime switching model; implied volatility index; nonlinear modeling (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (7)

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DOI: 10.1142/S0219091512500075

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