The Effect of Long Memory in Volatility on Stock Market Fluctuations

Bent Jesper Christensen and Morten Nielsen

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: 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.

Keywords: Financial leverage; long memory; realized volatility; risk-return trade-off; stochastic volatility; stock prices; VARMA models; VIX implied volatility. (search for similar items in EconPapers)
JEL-codes: C32 G12 (search for similar items in EconPapers)
Pages: 44
Date: 2007-05-11
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Citations: View citations in EconPapers (58)

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Journal Article: The Effect of Long Memory in Volatility on Stock Market Fluctuations (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2007-03

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