The impact of financial crises on the risk-return tradeoff and the leverage effect

Bent Jesper Christensen, Morten ßrregaard Nielsen and Jie Zhu

No 274615, Queen's Economics Department Working Papers from Queen's University - Department of Economics

Abstract: We investigate the impact of financial crises on two fundamental features of stock returns, namely, the risk-return tradeoff and the leverage effect. We apply the fraction- ally integrated exponential GARCH-in-mean (FIEGARCH-M) model for daily stock return data, which includes both features and allows the co-existence of long memory in volatility and short memory in returns. We extend this model to allow the financial parameters governing the volatility-in-mean effect and the leverage effect to change during financial crises. An application to the daily U.S. stock index return series from 1926 through 2010 shows that both financial effects increase significantly during crises. Strikingly, the risk-return tradeoff is significantly positive only during financial crises, and insignificant during non-crisis periods. The leverage effect is negative throughout, but increases significantly by about 50% in magnitude during financial crises. No such changes are observed during NBER recessions, so in this sense financial crises are spe- cial. Applications to a number of major developed and emerging international stock markets confirm the increase in the leverage effect, whereas the international evidence on the risk-return tradeoff is mixed.

Keywords: Financial Economics; International Development (search for similar items in EconPapers)
Pages: 29
Date: 2012-05
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Related works:
Journal Article: The impact of financial crises on the risk–return tradeoff and the leverage effect (2015)
Working Paper: The impact of financial crises on the risk-return tradeoff and the leverage effect (2012)
Working Paper: The Impact Of Financial Crises On The Risk-return Tradeoff And The Leverage Effect (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:ags:quedwp:274615

DOI: 10.22004/ag.econ.274615

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