Equity Risk and Return across Hidden Market Regimes

Dmitry A Endovitsky,Viacheslav V Korotkikh,Denis A Khripushin

doi:10.3390/risks9110188

Abstract

The key to understanding the dynamics of stock markets, particularly the mechanisms of their changes, is in the concept of the market regime. It is regarded as a regular transition from one state to another. Although the market agenda is never the same, its functioning regime allows us to reveal the logic of its development. The article employs the concept of financial turbulence to identify hidden market regimes. These are revealed through the ratio of the components, which describe single changes of correlated risks and volatility. The combinations of typical and atypical variates of correlational and magnitude components of financial turbulence allowed four hidden regimes to be revealed. These were arranged by the degree of financial turbulence, conceptually analyzed and assessed from the perspective of their duration. The empirical data demonstrated ETF day trading profits for S&P 500 sectors, covering the period of January 1998–August 2020, as well as day trade profits of the Russian blue chips within the period of October 2006–February 2021. The results show a significant difference in regard to the market performance and volatility, which depend on hidden regimes. Both sample data groups demonstrated similar contemporaneous and lagged effects, which allows the prediction of volatility jumps in the periods following atypical correlations.

Highlights

The focus of this study is to develop a methodology for detecting the hidden regimes of stock markets caused by financial turbulence patterns, as well as the analysis of their impact on risk and return values
The approach suggested by Chow et al was to mainly generalize the Markowitz portfolio theory and observe various stock market regimes with a view to improving its sustainability, on the whole, it was the Mahalanobis distance concept that became the basis for developing special measures for measuring financial turbulence in a market
These results suggest that our hidden market regimes contain incremental information about future return and volatility

Summary

Introduction

The reasons for such events may be different, the events themselves are assumed to reveal similar patterns and follow almost the same logic. Both the participants of stock markets and the academic community seek opportunities to identify the common pattern of all crises observed in developed and emerging markets. The primary focus of this research is on the S&P 500 market index measured the performance of the most capitalized companies in the most developed stock market. The secondary focus is on the main Russian equity index, the RTSI index, which measured the performance of the most capitalized companies in the emerging markets of BRIC

Methods

Findings

Discussion

Conclusion