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Economic Value of Modeling the Joint Distribution of Returns and Volatility: Leverage Timing

Cem Çakmaklı () and Verda Ozturk ()
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Verda Ozturk: Duke University

Koç University-TUSIAD Economic Research Forum Working Papers from Koc University-TUSIAD Economic Research Forum

Abstract: We propose a joint modeling strategy for timing the joint distribution of the returns and their volatility. We do this by incorporating the potentially asymmetric links into the system of ‘independent’ predictive regressions of returns and volatility, allowing for asymmetric cross-correlations, denoted as instantaneous leverage effects, in addition to cross-autocorrelations between returns and volatility, denoted as intertemporal leverage effects. We show that while the conventional intertemporal leverage effects bear little economic value, our results point to the sizeable value of exploiting the contemporaneous asymmetric link between returns and volatility. Specifically, a mean-variance investor would be willing to pay several hundred basis points to switch from the strategies based on conventional predictive regressions of mean and volatility in isolation of each other to the joint models of returns and its volatility, taking the link between these two moments into account. Moreover, our findings are robust to various effects documented in the literature.

Keywords: Economic value; system of equations; leverage timing; market timing; volatility timing. (search for similar items in EconPapers)
JEL-codes: C30 C52 C53 C58 G11 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2021-07
New Economics Papers: this item is included in nep-ecm, nep-fmk, nep-isf, nep-ore and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:koc:wpaper:2110

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